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Jeff Saut: Credit Markets First Sign of Stability


Last week may have marked the beginnings of a stabilizing trading bottom.

According to Merrill Lynch's David Rosenberg, these passages are the most important quips from Ben Bernanke's recent speech:

"Stabilization of the financial markets is a critical first step - but even if they stabilize, as we hope they will, broader economic recovery will not happen right away. Economic activity had been decelerating even before the recent intensification of the crisis. The housing market continues to be a primary source of weakness in the real economy, as well as in the financial markets, and we have seen marked slowdowns in consumer spending, business investment, and the labor market. Credit markets will take some time to unfreeze.

"...Inflation has been elevated recently, reflecting the steep increases in the prices of oil, other commodities, and imports that occurred earlier this year, as well as some pass-through by firms of their higher costs of production. However, expected inflation, as measured by consumer surveys and inflation-indexed Treasury securities, has held steady or eased, and prices of imports now appear to be decelerating. These developments, together with the recent declines in prices of oil and other commodities as well as the likelihood that economic activity will fall short of potential for a time, should lead to rates of inflation more consistent with price stability."

Mr. Rosenberg concludes by noting:

"His view on the economy and on inflation can only lead us to one conclusion - these guys are not done cutting rates, and there's still 150 basis points separating the current funds rate from where it ultimately went in Japan. Quantitative easing comes after that if financial conditions fail to improve. We're not sure how many more rabbits policymakers have left in their hats outside of the Fed taking rates to zero and buying Treasuries outright."

As my readers know, I've always thought the credit markets are smarter than the equity markets, and therefore have been watching various credit spreads intently. The credit markets, ladies and gentlemen, will be the first "tell" as to when things will stabilize - and Mr. Bernanke is correct that "stabilization of the financial markets is a critical first step."

Late last week, the "first steps" to some kind of stabilization seemed to occur. For example, the November Eurodollar contract was sharply lower on Friday, as was the 3-month LIBOR interest rate. Rumors swirled that a major bank was lending heavily in the inter-bank market and the credit markets took a baby step toward thawing. I'm hopeful that this will spill over into equity markets, this week because the set-up for at least a trading bottom looks promising.
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