Mixed Messages

The irony in today’s news is that just as the economy is declining into what will probably be a nasty recession, there are the first flickers of hope that the worst case scenarios everyone has been playing with – depression era stuff – are almost certainly now not going to happen. Here’s the New York Times reporting:Wall Street Rises After Report on Economy

The key comments here are that the Commercial Paper market is coming back to life and that the spreads on LIBOR are returning to more normal ranges.

Commercial Paper is the short term loan of preference for most of large corporate America. For instance GMAC funds a good percentage of its loans by borrowing commercial paper. If that market dries up the way it did recently then no matter how keen GMAC is to make loans it simply has no way of doing so. Worse: as its pre-existing commercial paper borrowing comes due for repayment it had no way of re-financing it. That was a major source of concern for many large companies. To the extent that the commercial paper market is now coming back to life a significant part of the credit crunch will ease.

That same goes for LIBOR spreads. Those spreads had reached extraordinarily high levels reflecting the complete lack of confidence that banks had in each other. Now that major governments around the world have pumped money into the market in sufficient amounts to abate concerns of both illiquidity and insolvency banks are now beginning to lend to each other. That will also ease the credit crunch.

None of this will stop the downward spiral in the non-financial parts of the economy. That decline is now being driven by consumers who are under siege as unemployment rises and wages stagnate. As long as consumers dig in and stop spending the economy will falter. It looks as if consumer sentiment is still falling so the prospects for this holiday season are grim. That’s why many firms are bracing for the worst and retrenching. Slashing the workforce is the first and easiest way of cutting operating expense. So we can expect unemployment to rise sharply in the next two or three quarters, probably peaking at around 8% to 8.5% next fall. As long as workers fear for their jobs they won’t spend, so the prospects are for slow sales through the spring at least.

Thus we can also expect two or three quarters of contraction in GDP.

In short a nasty recession. But not a depression!