We found out yesterday afternoon that banks are becoming less and less dependent on the government for their short-term funding needs.  This is no doubt a sign of a healthier lending market and a desire to stop relying on the government for aid:

“WASHINGTON — Banks have trimmed their borrowing from the Federal Reserve’s emergency lending program, an encouraging sign that some credit stresses are abating.

The Fed on Thursday said commercial banks averaged $36.2 billion in daily borrowing over the week that ended Wednesday. That was down from $36.9 billion in the week ending June 10.

Investment firms didn’t draw any loans for the fifth straight week. The last time they drew any money – just $482 million – was in the week that ended May 13.”

In addition to reduced lending, the Fed also reported a substantial decline in commercial paper issuance.

In another promising sign, the report showed the Fed’s net holdings of “commercial paper” averaged $136 billion over the week that ended Wednesday, a decrease of $4.8 billion from the previous week.

Commercial paper is the crucial short-term debt that companies use to pay everyday expenses, which the Fed began buying under the first-of-its-kind program on Oct. 27, a time of intensified credit problems. The central bank has said about $1.3 trillion worth of commercial paper would qualify.

While the market rallied a bit in the after hours market on this news I believe the market is overlooking a much larger problem.  While it is a good sign that companies aren’t reaching out for short-term government funding it is also alarming that commercial paper issuance continues to fall off a cliff.  Commercial paper is used to finance a corporation’s short-term funding needs.  Inventories and salaries are two primary uses.  Obviously, as job losses mount the need for commercial paper has declined.  Curiously, as the pace of job declines slows the commercial paper market continues to decline rapidly.  I believe this is a sign that inventories remain high and economic activity remains sluggish.  The news we get every week from jobless claims and the rails corroborates such thinking (see here for more on this).

As companies cut costs and subsequently reduce their need for short-term funding we’ve seen positive follow-thru to the bottom line in corporations.  I have been quick to point out this trend in earnings of late (FedEx is a prime example).  It’s not unusual to see a company miss revenues substantially and beat on the bottom line due to cost cutting.  This is good in the near-term, but is not a recipe for long-term growth.   The market has been celebrating this performance lately, but will realize over time that revenues are the only path to organic growth (the holy grail of higher stock prices).  Unfortunately, the commercial paper markets are representing this sluggish and defensive business activity.

The deceleration in commercial paper has had a very high correlation with economic activity in the last two years.  The recent cliff dive in commercial paper represents how weak near-term business activity has been across the economy.  I would expect to see a substantial acceleration in the ABCP market before we see any sharp acceleration in economic activity.  As of now, the commercial paper market is nothing more than a sure sign that the so called “recovery” is beyond weak and is perhaps even weaker than many “green shoot” theorists assume.  A double dip recession is looking more and more possible as we move into the second half of the year….

Source: AP