Around the Street: Credit Freeze, Economic Chill

Wall Street economists and strategists take a dire view of prospects for the U.S. economy

As investors await the fate of the U.S. financial-system rescue plan, scheduled for a vote in the House of Representatives on Oct. 5, credit markets remain under enormous strain. And the freeze-up in lending activity does not bode well for U.S. economic growth in coming months.

To get a sense of the situation, BusinessWeek and S&P MarketScope compiled insights from Wall Street strategists and economists on Oct. 1:

Tony Crescenzi, Miller Tabak

For a third week, the total amount of commercial paper outstanding plunged, falling a record $94.9 billion in the week ended Oct. 1, to $1.607 trillion, bringing the cumulative drop for the three weeks to $208 billion. The declines reflect the seizing up of the credit market and withdrawals of money from money-market funds, which held $700 billion of commercial paper at the end of the second quarter. These declines in some ways carry more weight than those of a year ago, when the market was purging issuers with mortgage-related exposures. This time the purge is broad and is affecting issuers with far more predictable cash flows—regular run-of-the-mill companies in need of working capital. For example, the asset-backed sector saw a $29.1 billion decline in the latest week, news that fits with the poor level of car sales, which are falling under the weight of the lack of availability of credit. The declines add to the urgency for fixes to the credit crisis and bolster the case for a Fed rate cut.

Action Economics

U.S. credit default swaps are widening amid weakness in equities and rising concerns a recession will further weigh on already vulnerable corporate [issuers]. Meanwhile, CDS on the insurance sector are really taking it on the chin after Senator Harry Reid (D-Nev.) said yesterday that a major insurer was on the verge of bankruptcy if the bailout package wasn't passed. MetLife (MET) is now priced at 12% up front and $500,000 per year, with Hartford (HIG) and Prudential (PRU) at 1.05% up front and $500,000 per year to insure $10 million in bonds. Yesterday there was no up-front charge for any of the insurers, with MetLife's cost of insurance at $460,000, Hartford at $525,000, and Prudential at $500,000. This is one more sign of the anxiety in the markets, of course fear in this sector has been exacerbated by the debacle with AIG.

Michael Anderson, Barclays Capital (BCS)

In one of the most monumental months in the history of capital markets, high-yield corporates plunged 7.98%, marking the worst-ever monthly return for the asset class. The prior record, -7.37%, was set in June 2002 during WorldCom's collapse. On a curve-adjusted basis, the High Yield Index lagged Treasuries by 855 basis points, the third-worst monthly performance. September 2008 trails only September 2001 (-885 basis points) and June 2002 (-882 basis points).

Seamus Smythe, Goldman Sachs (GS)

The September employment report [scheduled for release on Oct. 3] is likely to be quite weak; we look for a loss of 150,000 jobs and a further increase in the unemployment rate to 6.2%. A variety of factors point to the weak report: (1) unemployment insurance claims appear to have risen underneath various distortions; (2) consumers view jobs as increasingly hard to get; and (3) hiring continues to be weak. The only sign that points to a somewhat better report, a loss of 8,000 private-sector jobs in the ADP employment report, is from a survey that has done quite poorly recently.

Of particular note in this month's release, the Bureau of Labor Statistics (BLS) will release preliminary estimates of the benchmark revision to payroll employment. These revisions cover the year from March 2007 to March 2008. Based on other data, our best estimate is that the revision will be downward by about 250,000 and potentially more, but this estimate is quite tentative.

David Wyss, Standard & Poor's (MHP)

[Inflation-adjusted] gross domestic product for the second quarter is ancient history, but the downward revision to 2.8% real growth from the 3.3% reported earlier was still disturbing. Most of the revision came from consumer spending, with real growth revised to 1.2% from the 1.7% reported last month. Oddly, the biggest revision was to services (1.3% to 0.7%), usually a very stable series. The data suggest more downside risks for the economy in coming quarters. We still expect the third quarter to be positive, but not by much.

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