Mile / Alan:
You guys have breached a topic which is my current obsession! :)
Here's a contrary view from Business Week, saying that cuts will come:
A BREAK IN THE CLOUDS
The markets are calmer, but the Fed's work is far from over
Are we out of the woods? Equity investors seem optimistic. The market for high-quality corporate debt is reviving. Even risk premiums on emerging-market debt have fallen a bit since the Federal Reserve cut interest rates for the second time in a month on Oct 15. Investors could almost be forgiven for thinking the worst of the market gridlock is behind us. All that talk of a liquidity crunch--maybe even the fears of an economic slowdown in the U.S.--suddenly seems almost passe.
But not quite. Even if Wall Street is shrugging off weak third-quarter earnings by major companies and focusing on pleasant upside surprises, the outlook for the U.S. economy--which prompted the Fed's cuts--has really changed. And while the capital markets have stepped back from the brink of a liquidity crisis, the situation is far from normal. Nearly 150 companies that filed in June or earlier to make initial public offerings still haven't come to market, according to Securities Data Co. Risk premiums for bonds remain far above normal levels. And companies that used to count on public equity and debt are resorting to costlier bank financing.
All this has Fed Chairman Alan Greenspan watching carefully for signs that further cuts are needed. While the stock market has gotten a psychological boost from lower rates, he's concerned that U.S. credit markets are still distorted, with corporate borrowers forced to resort to costly bank financing. He also worries that U.S. markets remain vulnerable to global problems. Brazil has come up with an economic reform package that may forestall devaluation across Latin America. But Japan's efforts to overhaul its banking system are still preliminary. And other banking or hedge-fund disasters, a la Long-Term Capital Management, are possible.
The bottom line: Whatever the Dow Jones industrial average may say, the U.S. economy is still likely to slow or even fall into a recession next year. Thanks to the capital-markets turmoil, ''the cost of capital has gone up--and that will make business a lot more cautious,'' says James Glassman, economist at Chase Securities Inc. Industrial production has already slowed, and companies are rethinking plans for capital spending. ''A slowdown is already inevitable,'' says Allen Sinai, chief executive of Primark Decision Economics Inc.
One ominous sign is the persistent anomalies in capital markets. Consider a gauge that Greenspan watches: the difference in yield between the most recently issued 30-year Treasury bond and the ''off-the-run'' bond, or those issued just months before. Typically, off-the-run bonds yield 5 basis points more than new issues. But in the credit-market panic after Russia's default, that premium shot up to 34 basis points, as traders refused to hold anything but the most liquid securities. The premium has narrowed a bit, to 18 basis points. But Greenspan figures the markets can't be deemed healthy until the off-the-run spread is back around the normal 5-point premium.
The picture remains mixed, too, in the corporate bond market. On Oct. 27, Associates Corp. of North America, the funding unit of Associates First Capital Corp., sold $4.8 billion in bonds--the second-largest corporate debt deal ever. To get the issue sold, underwriters were willing to offer relatively high yields.
Across the markets, blue-chip borrowers are finding that investors want more: Ten-year notes issued by Chase Manhattan Corp. (CMB)--a benchmark for the financial-services industry--sold early this year at a yield 70 basis points over Treasuries. The issue plunged in early October as the market demanded a 230-basis-point spread. ''[The yield] shot up like a child's fever,'' says Robert V. DiClemente, chief economist at Salomon Smith Barney. Even now, the Chase issue still yields 150 basis points above 10-year Treasuries.
Things are far worse at the market's low end. No junk bonds were issued in the two weeks ending Sept. 12, though a few were in late September, possibly because underwriters were trying to boost their quarterly standings, says Securities Data spokesman Richard Peterson. Issues in October--through the 27th--were about $1 billion, vs. $19 billion in April.
''GUN-SHY.'' The market for new equities isn't great, either. Oil company Conoco Inc. (COC) raised $4.4 billion as it spun out of DuPont (DD) on Oct. 21. But only 10 IPOs have been filed in October, compared with 75 in March. ''Everyone's kind of treading water,'' says Robert A. Maley, senior vice-president of Gilford Securities Inc., which is planning to underwrite an offering for 21st Century Holdings Co., a Plantation (Fla.) insurance company, in early November. ''Institutional investors have had a tough go of it. They drive the market, and they're a little gun-shy.''
The alternative for companies is the banks. Corporate borrowers who have spent the past 15 years weaning themselves from bank loans are showing up on their loan officers' doorsteps. And banks are willing to help them--for a price. For example, the up-front fees that lower-rated companies pay on loan syndications rose by as much as 233% in October, says the Loan Pricing Corp., which tracks the market. Says Arthur P. Davis, III, LPC president: ''It is no longer a borrower's market.''
This turn to bank lending leaves Fed officials with mixed emotions. While they're glad banks are lending, Fed officials fret the increased costs will crimp corporate budgets and slow capital spending, putting downward pressure on the economy.
What can the Fed do? Some analysts say very little. Charles I. Clough Jr., chief investment strategist at Merrill Lynch & Co., says credit markets are contracting because there aren't enough worthy borrowers. ''The problem is the incremental borrower is increasingly a defaulting borrower,'' says Clough. ''It wouldn't matter if the fed funds rate was 5% or 4% or 3%, there will still be a slowdown in business investment.''
But Greenspan disagrees. His concern--and what prompted the second cut--is that worthy borrowers are losing access to capital. He and his Fed colleagues are ready to repeat the dose of medicine they administered in 1991, when a series of rate cuts broke a real credit crunch by slashing banks' costs of funds.
Even now, there's plenty of room to cut--and Wall Street is looking for more easing. The federal funds rate--what banks charge each other for overnight loans--now stands at 5%. That's still way above the rate for other short-term loans: Six-month Treasuries now yield just 4.16%. But this time, banks aren't the problem--credit markets are. And getting investors to let down their guard could require a long campaign of lower rates to keep financial turmoil from pushing the U.S. into recession.
By Gary Silverman and Peter Coy in New York, and Mike McNamee in Washington>> |
