It has been two months since the credit markets began to signal that something was seriously wrong in the global financial system. In recent weeks a lot has gone right, both in the markets and in the economy. In particular, investors have bid up stock prices as if they just heard an all-clear signal. The Labor Dept. gave the latest green light when it reported a solid 110,000 gain in September payrolls and an eye-popping upward revision to August jobs, from a decline of 4,000 to a jump of 89,000. Those numbers calmed recession fears. Are we really out of harm's way?
Don't get too excited just yet. The problems that flared up in August are unprecedented in that the housing recession is at the center of a vicious cycle that only a housing recovery can break. As long as the housing slump continues to worsen, financial markets will be susceptible to more shocks and businesses and consumers will be vulnerable to additional credit tightening.
After two months, the money markets are on the mend, but they are not yet fully recovered—and there's no end in sight for the housing bust. On the plus side, the volatility in short-term money-market rates has died down. Liquidity is returning to the previously frozen commercial paper market, which is crucial to many businesses' short-term funding. Rates on asset-backed commercial paper (ABCP)—securities that are mostly tied to mortgages—have returned to normal levels.
However, the volume of ABCP outstanding continued to shrink through Oct. 3, although the weekly declines are getting smaller. Interbank rates such as the London Interbank Offered Rate (LIBOR), to which much business borrowing is pegged, remain unusually high. That's a sign investors are still fretting over financial institutions' exposure to many asset-backed securities of uncertain value.
Against this improving—but still unsettled—financial climate, the news from the broader economy has been mostly positive for the third quarter, but it suggests growth is losing momentum. Minutes from the Federal Reserve's Sept. 18 meeting indicate staffers cut their forecast for fourth-quarter growth. Despite the upbeat sentiment generated by the September job numbers, a closer look shows the pace of hiring has slowed considerably.
Even after revisions, mainly in government jobs, third-quarter payroll gains averaged only 97,000 per month, down from 126,000 in the second quarter and 142,000 in the first quarter. Job growth is already too slow to prevent unemployment from rising. The jobless rate in September stood at 4.7%, up from 4.4% in March, and it will go higher. Plus, a preliminary annual revision by the Labor Dept. showed payroll gains from March, 2006, to March, 2007, were about 25,000 per month less than previously reported.
Hiring has been weak in areas that tend to be most sensitive to fading business activity. Outside of strong gains in health care, where jobs have been driven by demographic changes, the payroll slowdown has been even sharper. Temporary jobs, a key indicator of future hiring, dropped in September for the eighth month in a row, the longest decline since the 2001 recession.
What's more, it's not just housing. Even excluding residential construction and other areas of manufacturing, retailing, and finance tied to housing activity, job growth in the private sector has still slowed notably. That's a sign the housing slump is taking a toll on the broader economy.
Bottom line: The August turmoil is far from played out. A deepening housing recession, tighter credit, and more cautious spending by businesses and consumers are sure to weigh further on the job markets and overall growth. Fed Vice-Chairman Donald L. Kohn summed up the uncertainty in the outlook on Oct. 5: "We do not know how financial markets will evolve, and we do not know how households and businesses will respond to financial developments." That's why investors shouldn't get ahead of themselves.
By James C. Cooper