As of this writing the markets were encountering another major sentiment junction. Clearly the stock market has been factoring in an improvement in overall conditions since early March, but seeing US retail sales fall sharply and seeing patently deflationary readings from the monthly inflation measures seemed to ratchet up slowing fears in the week following the Easter holiday. Surprisingly, while the macroeconomic outlook was apparently deteriorating, the financial/banking sector seemed to be gaining some footing. While the financial sector appears to be a long way from being self-sustaining and being into an entrenched recovery move, seeing signs that some banks might return TARP funds would appear to reduce the pressure on government funds and in turn point to the prospect that the extremely favorable yield curve is providing a lift to some banks. While some analysts and government officials are concerned that giving back the TARP funds might restrict lending activities and the speed of recovery, having several mid tolarge size players return the money could be a confidence- builder.
Goldman Sachs Group, Inc.
Somewhat more surprising is the fact that stock prices faltered last week, despite growing talk of “green shoots of recovery” and also in the face of what seemed to be an uptick in consumer and investor sentiment. We have maintained for a long time that recovery would be extremely difficult and perhaps unlikely as long as the markets faced the twin burdens of “undefined financial sector issues” and undefined classic economic slowing. While it might be premature to call for the end to the financial crisis, there are numerous signs of improvement from a number of different angles. First of all, the mere mention of a return of TARP funds would seem to be a long-term positive. Second, seeing ongoing improvement in the LIBOR-OIS (overnight index swap rate) spread would seem to suggest that credit market anxiety is also on the decline.
Weekly 3 Month Libor – OIS Spread
Clearly, the markets are still bracing for even higher unemployment rate readings ahead, and there will certainly be more classical business failures and perhaps problems in commercial real estate, but instead of the turmoil spinning out of control, it appears that the magnitude and the duration of the financial crisis is set to shrink.
Many markets have at times over the last six months seemingly factored in depression pricing, while others have only seemed to factor in sustained-recession pricing. We are not suggesting that a quick economic recovery is in the works, but we are suggesting that it is poised to move out of intensive care. The burden of high unemployment will continue and more businesses are probably going to fail, but as the press has been proclaiming, the second derivative of slowing on the economy creates the potential for an eventual end of the crisis.
