It’s getting ugly out there. Most major stockmarkets have entered bear territory – a 20% drop from their latest peak – as the credit crunch has tightened its grip and the macroeconomic outlook has worsened. In a clear sign that “the financial emergency isn’t over”, as Nils Pratley put it in The Guardian, Fed chairman Ben Bernanke is set to extend US investment banks’ access to emergency cash from the Federal Reserve into next year.
The Fed was going to wind down this emergency liquidity facility this year if credit conditions improved – but if anything, they’ve got worse, as William O’Donnell of UBS notes. Interbank lending rates have been on the rise again, while this week the iTraxx index, which gauges the risk of default of European high-yield bonds, has jumped back to late March levels. Meanwhile, US commercial bank lending has stagnated since April.
More writedowns to come…
A major worry is that banks face further writedowns and cash calls as the American housing market and the overall economy weaken further. This week, IndyMac Bancorp, one of America’s largest mortgage lenders, slashed half its workforce after it failed to raise fresh capital from investors following a hit from dodgy mortgages, and appears to be heading for collapse.
Further trouble in the housing sector is on the cards as the house-price slide is accelerating amid tighter credit – which has raised mortgage rates – and the near-record supply of unsold homes, while foreclosures are rising. Foreclosure filings were up 48% year-on-year in May. And we’re not just talking mortgage-related losses. Expect writedowns related to credit-card debt and commercial real estate too. The weakening economy is set to trigger a “second wave of the financial crisis”, as Gerald Kirchler of Flossbach & von Storch put it. More bank writedowns imply a further reduction in lending and economic growth.
…as wider economy weakens
The medium-term outlook is grim, says Capital Economics. The temporary boost to consumption from the Government’s tax rebates “will paper over the cracks for a few more months”, but the surge in energy prices, collapsing household wealth as house prices decline – consumer confidence is at a 28-year low – rising unemployment and tightening credit all point to a nastier downturn later this year. Morgan Stanley takes a similar view, pencilling in a negative growth in the fourth quarter and the first quarter of 2009. Markets are only just beginning to factor in the “morphing of the credit crunch into a full-scale US economic disruption”, said Mohamed El-Erian of Pimco in the FT. So much for the worst being over.