Monday, July 9, 2007

Will Tougher Conditions in the Credit Markets Slow the Economy?

The article is Bloomberg suggests that the tougher conditions in the credit markets will begin slowing the economy. The consumer is struggling with loan payments and purchasing, therefore retail sales are down. Also the corporate buy-out mania of the last 2 to 3 years to beginning to slow due to higher risk premiums and tougher covenants.

What started as a financing squeeze in the subprime- mortgage market now threatens other parts of the economy. Borrowing costs for companies are climbing as banks and investors demand more for their money. Consumers feel the pinch from rising interest rates and sagging house prices.

As a result, the economy may struggle to achieve the 2-1/2 to 3 percent growth rate that most forecasters inside and outside the Fed have penciled in for the second half of the year. Instead, economists at International Strategy & Investment Group, UBS AG and Commerzbank AG see growth below 2 percent as consumer spending slows and business investment fails to pick up under the weight of tougher financing conditions.

Please note the European Banks are better at calling the reality of the economic and financial future in the US than the US is. For example, they were the first to call the "recession" in the housing market in the US over a year ago. This ability to make more accurate calls is probably due to less media pressure when they make calls the US may not like. Oh, the politics of forecasting.

Investors now demand almost 3 percentage points in extra interest to own U.S. high-yield bonds rather than government debt, compared with a record low of 2.41 percentage points on June 5, Merrill Lynch & Co. data show. That's the fastest increase in spreads since April 2005.

``The credit cycle is peaking,'' says John Lonski, chief economist at ratings company Moody's Investors Service in New York. He sees the high-yield spread rising to 4 percentage points by the end of 2007.

The tougher corporate-credit conditions are starting to bite. In the past two weeks, more than a dozen companies postponed or restructured debt sales.

The biggest worry is that falling home prices and rising interest rates will undermine consumer spending, the bedrock of the economy.

Retailers feel the fall-out. The International Council of Shopping Centers and UBS Securities last week cut their forecast for June sales growth at retailers to 1.5 to 2 percent, from 2 percent.

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