Despite Rate Cut, Credit Markets Not Out of the Woods Just Yet

Greeting investors this morning, a headline in Bloomberg noted that the yen appreciated overnight against the other currencies, more evidence of the carry-trade unwind, due to the fact that “credit market losses are spreading.”

News out of the UK indicates that the run on the bank at Northern Rock Plc, another victim of the sub-prime mess, has left the British deposit protection plan (the rough equivalent of U.S. FDIC insurance) short of cash to cope with the bailout of the bank.

According to Bloomberg, “Northern Rock customers withdrew an estimated 2 billion pounds” in deposits from the troubled mortgage lender in recent weeks.

Trouble is, “the U.K. Financial Services Compensation Scheme holds 4.4 million pounds ($8.9 million), while a similar U.S. fund has $49 billion. The plan may have to increase insurance fees from participating banks.”

More Sub-Prime Induced Market Shocks

Meanwhile in Canada, investors are running from the Canadian commercial paper markets, freezing-up about $40 Billion worth of CP rollovers. Seventeen funds run by Canadian finance companies "couldn't raise money to pay back lenders, according to ratings company DBRS Ltd" due to fears of more fallout from the sub-prime contagion.

Beginning in July, “growing defaults in U.S. home loans caused the cost of borrowing to increase for all but the most creditworthy companies. Rates on asset-backed commercial paper soared, rising to six-year highs in the U.S.” according to Bloomberg.

Even the International Monetary Fund, which has repeatedly raised its estimates for global growth (most recently to 5.2% this year), has warned that “instability stemming from credit-market turmoil in the U.S. is ‘likely to be protracted,’ according to the Bloomberg article.

More Soft Economic Data out of U.S.

Today, the National Association of Realtors should report another slump in existing home sales, expected to drop another 5% in the most recent month, while consumer confidence is expected to slump in September.

The ongoing housing recession is likely to get much worse in coming months, as an estimated $600 billion in adjustable-rate mortgages ratchet up to higher monthly payments.

This will pressure home prices further, as more homeowners throw in the towel and sell at fire-sale prices – dragging down Americans' wealth even more.

And for those homeowners who manage to hang in there with higher mortgage payments, discretionary spending on other “stuff” will most certainly slow.

Bottom line: Fed rate cut or no – we’re not out of the woods just yet.