UPDATE 2-US commercial paper grows for a 10th week--Fed

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By Walden Siew and John Parry

NEW YORK Oct 22 (Reuters) - The U.S. commercial paper market expanded for a 10th straight week, adding to evidence of economic recovery from a U.S. recession that began in December 2007, Federal Reserve data showed on Thursday.

The commercial paper market, which the U.S. central bank had to rescue from a deep freeze last year, is flowing much more smoothly than a few months ago, analysts say.

For the week ended Oct. 21, the size of the U.S. commercial paper market, a vital source of short-term funding for daily operations at many companies, rose by $39.9 billion to $1.366 trillion outstanding, from $1.326 trillion the previous week.

"This is some indication that things are working again, that borrowers are tapping the commercial paper market and that it is serving the function it is supposed to," said Ray Stone, economist with Stone & McCarthy Research Associates, in Princeton, New Jersey.

The overall U.S. commercial paper market peaked at about $2.2 trillion outstanding in August 2007 before being dramatically eroded in the credit crisis.

The incipient recovery of the commercial paper market over the past two months "is also reflective of a macro economic phenomenon," Stone said. "The inventory liquidation drag on gross domestic product is running its course," he added.

Asset-backed commercial paper outstanding rose by $5.9 billion after a rise of $11.3 billion the previous week.

U.S. asset-backed commercial paper outstanding rose to $548.6 billion in the latest week from $542.7 billion the previous week.

"We are looking at commercial paper for signs of what is happening with current output," said Tony Crescenzi, market strategist and portfolio manager with Pacific Investment Management Co. (PIMCO) in Newport Beach, California.

Commercial paper data coincides with data showing an upturn in steel production for 17 straight weeks, Crescenzi said.

"Data last week showed that business inventories were falling into balance," Crescenzi added.

Business inventories may start to be rebuilt in coming months, provided that sales strengthen, he said.

Unsecured financial issuance outstanding rose $27.9 billion after a rise of $22.2 billion the previous week. (Reporting by Walden Siew and John Parry; Editing by Kenneth Barry)