US commercial paper market still contracting - indicating trouble ahead

David Rosenberg of GluskinSheff draws attention to the continuing contraction of the US commercial paper market, one of the main portals of funding for medium-sized enterprises in the country. In his latest report he writes (our emphasis):

We continue to hear from strategists and economists that the credit clouds have parted, and yet the U.S. commercial paper market continues to contract (by $40 billion in the July 15th week) to a level not seen since 1998. And, the declines are right across the board — financial issuers, non-financial, asset backed — in fact, the asset backed market is all the way down to $440 billion of outstandings from $1.2 trillion at the credit bubble peak in the summer of 2007. Commercial bank balance sheets also continue to shrink — by $12 billion in the latest week, with outstanding consumer credit falling the fastest.

In light of corporate lender CIT’s near bankruptcy and last-minute rescue — actually seen by many as more of a temporary band-aid than a permanent solution — goings on within the CP market should be of high interest. The following chart offered by Rosenberg, however, is hardly reassuring:



In light of corporate lender CIT’s near bankruptcy and last-minute rescue — actually seen by many as more of a temporary band-aid than a permanent solution — goings on within the CP market should be of high interest. The following chart offered by Rosenberg, however, is hardly reassuring:

Commercial paper - GluskinSheff

The point is that if CIT were to go down, corporates would hardly have a reliable source of alternative funding to available to them. While there is the argument the shrinkage stems from companies’ increased use of the Fed’s Commercial Paper Funding Facility, that’s hardly indicative of the market having returned to pre-crisis norms.

If anything, the above indicates increasingly prolonged government support being applied to the sector. This would only be heightened by CIT’s collapse.

http://ftalphaville.ft.com/blog/200...-but-troubles-still-brewing-in-the-cp-market/

 

I actually would view these developments in the CP mkt as positive, at the current juncture.

Firstly, a large chunk of CP issuance used to be done by financials. Given that, the continuing contraction of the CP mkt reflects much less supply coming out of banks. That, in turn, would imply that the banking system's funding duration is increasing, i.e. they no longer have to rely on ultra short-term instruments like repos and CP for cash.

Secondly, it could reflect the money mkt fund community anticipating new, healthier liquidity requirements and reducing their appetite for commercial paper (much of it used to be, again, A1/P1 financials).

Thirdly, the continuing demise of the various ABCP programs is not such a bad sign.

Generally, I would view these processes as healthy adjustments that need to happen. This is just my Z$2c...

 

Agreed partially. Your perspective is US banks` one. What about the implications to the broader economy ?

Ben Bernanke´s article in today´s WSJ online edition gives a hint as where problems occur ( emphasis mine ) - full text here :


The Fed’s Exit Strategy

http://online.wsj.com/article/SB10001424052970203946904574300050657897992.html

The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.

But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.

To some extent, reserves held by banks at the Fed will contract automatically, as improving financial conditions lead to reduced use of our short-term lending facilities, and ultimately to their wind down. Indeed, short-term credit extended by the Fed to financial institutions and other market participants has already fallen to less than $600 billion as of mid-July from about $1.5 trillion at the end of 2008. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Fed mature or are prepaid. However, reserves likely would remain quite high for several years unless additional policies are undertaken.

 

Yes, all true...

However, don't we sorta all universally agree that deleveraging and decreasing reliance on debt, esp ultra short-term debt, is a good and necessary thing? If that is the case, do we believe it needs to happen only in financial mkts or also in the real economy?

For example, let's take one of the big corps... If GE, for instance, decreases its participation in the CP mkt, I'd argue that it's a good thing and should be welcome.

Obviously, this credit contraction can overshoot and hurt the economy by restricting credit too much, which is where the danger lies. It's sorta like taking a crack addict off his pipe so quickly, he might just keel over. In my personal view, this is not the case here and we're just gently cutting down on the amount of crack available to the financial system.