Financial Market Troubles Worsen, 75bp Fed Cut More Probable

Any initial inklings that the credit market was beginning to thaw were quickly erased last week. The corporate sector did its part in stoking fear of borrowing or lending in current market conditions. Record losses reported in fourth quarter earnings numbers last week from Freddie Mac and AIG revealed subprime losses have spread to those bulwark firms that are responsible for securing home loans and even mainstream insurers who were expected to have little exposure to mortgages or defaulting debt. Federal Reserve Chairman Ben Bernanke seems to have made things even worse. Though the central banker has said he does not expect the US to fall into recession this year, he has projected further deterioration in the credit markets.

CREDIT MARKET: HOW IS IT DOING

Any initial inklings that the credit market was beginning to thaw were quickly erased last week. The corporate sector did its part in stoking fear of borrowing or lending in current market conditions. Record losses reported in fourth quarter earnings numbers last week from Freddie Mac and AIG revealed subprime losses have spread to those bulwark firms that are responsible for securing home loans and even mainstream insurers who were expected to have little exposure to mortgages or defaulting debt. Federal Reserve Chairman Ben Bernanke seems to have made things even worse. Though the central banker has said he does not expect the US to fall into recession this year, he has projected further deterioration in the credit markets.

A DEEPER LOOK INTO THE CHANGES THIS WEEK:

Risk premium behind potential credit defaults soared over the past week after AIG reported an $11 billion writedown related to troubled mortgages and mapped the virulent spread of the subprime contagion. The cost of securing debt against default surged 30 percent over the week. At the same time, the default premium of junk bonds over treasuries grew 6.4 percent.

Investment houses and lenders continue to transfer their assets to the relative safety of short-term debt. The rate of return at the short-end of the yield curve extended its steady decent last week after Freddie Mac and Fannie Mae reportedly tightened their lending standards and subprime-related losses spread to the mainstream insurer AIG.

STOCK MARKET: HOW IS IT DOING?

The equities rebound through the previous week was short-lived. Since last Wednesday, the Dow Industrial Average led a retreat among the benchmark stock indices with its own 3.4 percent decline. The selling in equities came hand-in-hand with a general flight from risk. However, it is also worth noting that with the turn, the Dow has confirmed a broad technical range between 12,750 and 12,000. Earnings announcements were the official trigger of this most recent downleg. The government backed mortgage giant Freddie Mac reported its largest quarterly loss in its history through the end of the year thanks to delinquent mortgage payments and foreclosures. The dour sentiment was carried through to Friday when Dow component AIG announced its own $5.29 billion dollar loss through the fourth quarter. This week, pressure has been kept up by data suggesting the US economy may be beginning its recession.

A DEEPER LOOK INTO THE CHANGES THIS WEEK:

The congestive price action in the broadly encompassing Dow index has been largely reflected of the market's largest sector components. Over the past week, the Financial group was the top loser with an incredible 6.3 percent drop in value owing to the credit market concerns involved in Freddie Mac's and AIG's record breaking losses. In the more consumer-sensitive sectors, Fed Chairman Bernanke's report on economic strength last week set fears of an oncoming recession, while the ISM's service and factory activity reports suggested it is already here.

Volatility in the financial sector has been stoked by a disproportionate amount of news and data. However, economic indicators were far less threatening than the many reports that crossed the wires. The earnings reports from Freddie Mac and AIG struck a nerve as they suggested subprime losses and credit problems were spreading to more stable institutions and mainstream insurance. These fears will most likely dominate the expected relief in a speculated 75 basis point Fed cut this month, leaving the financial markets in potentially dire straits.

U.S. CONSUMER: HOW ARE THEY DOING?

Multi-year lows in consumer confidence will likely be extended into coming months, as support through employment and income fade with the general downturn in the US economy. Last week, the University of Michigan confirmed a 16-year low in the final reading of its sentiment report. This dour report happened to cross the wires the same day as the government released statistics that revealed personal income growth cooled over the beginning of the year. Optimism has only worsened amid more recent news Fed commentary and data. Chairman Ben Bernanke's call for lenders to forgive portions of mortgages that are at risk of default may suggest there is little the government or central bank can do to salvage the housing market. Americans' chief concern now is whether labor and wage growth will hold - an unlikely proposition given the weak ADP.

A DEEPER LOOK INTO THE CHANGES THIS WEEK:

Fed Chairman Bernanke's outlook for further deterioration in the housing market didn't take long to confirm. Mortgage applications through the week ending February the 29th rose a modest 3 percent, following the massive 19.2 percent drop the week before. This considerable volatility has been facilitated by a weak buyers market as many American's are waiting until they are sure that their next investment will not immediately depreciate upon purchase. Also weighing on mortgage filings are tighter lending standards. Freddie Mac and Fannie Mae have added to the pressure by lifting their appraisal standards.

Consumer-based companies have seen their share value tumble over this past week as all fundamental signs are now pointing to substantial cooling consumer spending. Last week, the personal income report for January suggested only a slight cooling in wages. However, since then, indicators have reported contractions in both the service and manufacturing sectors - the two major sectors for the economy and employment. What's more, the forecast for job growth is rapidly deteriorating. The first contraction in the ADP private payroll report since 2003 has weighed forecasts for a potential NFP rebound on Friday.

DailyFX

Posted in: Economy,Finance and Investment,Forex