Banks and Fed to take stocks on rocky ride

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The rocky ride in US stocks looks set to intensify this week with the survival of one of the biggest investment banks in doubt and regulators rapidly burning through options to limit more damage to the financial system.

All eyes will again be on Bear Stearns tomorrow for any further word about the condition of the fifth-largest US investment bank, which on Friday had to get emergency funding as fallout from the global credit crisis took its toll.

Bear Stearns is among four major Wall Street firms reporting earnings this week. But the Federal Reserve’s policy-setting meeting on Tuesday will be the focus of the holiday-shortened week. The US stock market will be closed for Good Friday on March 21.

US interest-rate futures on Friday showed more than a 50 per cent chance that the central bank will cut its benchmark fed funds rate target by 100 basis points – or one per cent – to revive an economy that many say is already in recession.

“Most of the focus will be on the Federal Reserve this week. Will the Fed cut rates? And if so, how much? And most importantly, what will the statement that accompanies the decision say?” said Hugh Johnson, chief investment officer of Johnson Illington Advisors in Albany, New York.

Market participants have questioned the effectiveness of the US central bank’s efforts. On Tuesday, March 11, the Fed teamed up with other central banks to get up to $200 billion in fresh funds to cash-starved markets. The market rallied sharply for its best day in five years, but most of those gains were erased by the end of the week.

Then on Friday, Bear Stearns said a cash crunch forced it to turn to the Federal Reserve and JPMorgan Chase for emergency funds. That revived investors’ fears about the depth and breadth of the credit crunch. Bear’s stock tumbled as much as 50 per cent on Friday to a session low at $28.42, its lowest since October 1998.

The 28-day emergency line of funding for Bear Stearns came just days after Bear, which has been hard hit by its heavy exposure to the faltering US mortgage market, had dismissed market rumours of a cash crunch and said it was still a healthy player in the global web of trading and finance. That heightened concerns that there may be other banks facing liquidity issues.

More clarity about the extent of write-downs could come when four big US investment banks report earnings this week.

Bear Stearns is first out of the block tomorrow. Bear moved up its earnings release, which was initially scheduled for Thursday. The change in schedule may indicate that Bear plans to make a significant disclosure, said Rebecca Engmann Darst, equity options analyst at Interactive Brokers Group.

“Speculation is rising that Bear Stearns could be the subject of a takeover or ‘takeunder’ over the weekend – possibly with JPMorgan Chase,” she said.

Lehman Brothers and Goldman Sachs will report earnings on Tuesday, followed by Morgan Stanley on Wednesday. On Friday, Lehman’s stock was the second-biggest decliner among investment banks, falling 14.6 per cent, or $6.73, to close at $39.26 on the New York Stock Exchange.

Forecasts and stock prices have come down sharply for all the big banks, as the credit crunch spreads across almost every market.

With Friday’s slide, the S&P 500 was close to falling into a bear market. If it drops further this week, it could cross a threshold that normally indicates a bear market, which would be a drop of 20 per cent off its October closing high. The Nasdaq turned bearish last month.

It was a wild week, starting with last Monday’s revelations that a federal probe showed New York Governor Eliot Spitzer was “Client 9” who patronised a call girl working for a prostitution ring that charged rates of $1,000 an hour and up. That triggered a “schadenfreude festival” on Wall Street, where Spitzer had ferociously prosecuted wrongdoing during his years as New York attorney general. On Wednesday, the TVs on most trading desks were tuned in to watch live broadcasts of Spitzer’s resignation as governor.

By Friday, the governor’s scandal seemed like a faded memory when news broke about Bear Stearns’ liquidity crisis. At the closing bell, the Dow Jones industrial average was down 194.65 points, or 1.60 per cent, to end at 11,951.09, while the Standard & Poor’s 500 index was down 27.34 points, or 2.08 per cent, at 1,288.14, and the Nasdaq composite index was down 51.12 points, or 2.26 per cent, at 2,212.49.

For the week, the Dow Jones industrial average managed to finish with a gain of 0.48 per cent, thanks to Tuesday’s huge rally. But the Standard & Poor’s 500 index slipped 0.40 per cent for the week and the Nasdaq was unchanged – right to the penny. Since the end of February, the Dow has fallen 2.57 per cent and the S&P 500 has dropped 3.19 per cent, while the Nasdaq has declined 2.60 per cent.

For the year so far, the Dow has lost 9.90 per cent, the S&P 500 has dropped 12.27 per cent and the Nasdaq has tumbled 16.58 per cent.

Among the week’s key economic data will be the US Producer Price Index on Tuesday, which will get plenty of attention due to concerns about rising inflation even as the economy slows. Economists polled by Reuters expect February core PPI to rise 0.2 per cent.

On Friday, a government report unexpectedly showed February’s Consumer Price Index, another top inflation gauge, was unchanged. While that leaves more room for the Federal Reserve to cut interest rates, analysts were sceptical about the tame inflation picture painted by the data because prices of oil, gold and other commodities are at record highs.

Wall Street will get some other economic data this week that could give more clues about the US economy’s health, with industrial production and capacity utilisation due tomorrow and February housing starts set for Tuesday.

The weekly jobless claims as well as the Federal Reserve Bank of Philadelphia survey of regional business activity for March will round out the week on Thursday.

As the numbers pour in, Wall Street will have one question on its mind, said Johnson of Johnson Illington Advisors. “The question is: Did the economy enter a recession in February? We will get an answer to that question when we see the industrial production and housing numbers?” he asked. (Reuters)