Morgan Stanley sees 71 percent recession risk

NEW YORK (Reuters) - Despite the Federal Reserve's aggressive easing of monetary policy, equity and credit markets are suggesting that it is too late to avoid a recession, according to economists at Morgan Stanley.

Those markets suggest "it is too late to avoid the inevitable," said analysts Luca Bindelli and Stephen Jen in a research report.

"Indeed, the new senior loan officer survey (from the Federal Reserve) marks a further deterioration in credit conditions, and equity market performance has continued its descent," the Morgan Stanley economists said.

"Our preferred model now implies a risk of U.S. recession of 71 percent in the coming 12 months," they said.

The main drivers of this increase in recession risk were a further fall in equity market performance, a Fed senior loan officer survey that suggested a further tightening of credit conditions in the coming quarter, a drying up of the commercial paper outstanding market, and a further widening of the credit spread, the Morgan Stanley analysts said.

As was the case in December, these developments "more than compensated" for the decrease in the federal funds rate and three-month to 10-year spread, so that the overall risk of recession continued to increase, Morgan Stanley said.

LAST FED RATE CUT NOT ENTIRELY ACCOUNTED FOR IN MODEL

The 50-basis-point Fed interest rate cut on January 30 to 3.0 percent "is not entirely accounted for" in the model estimates, the analysts said, since the model accounts for financial market developments until the end of January.

"All things being equal, accounting for the latest Fed cut to 3.0 percent would lower the probability of our preferred model to 58 percent," the analysts said.

"If, furthermore, the yield spread narrows by 50 basis points, the probability (of a recession in the coming 12 months) would decline to 41 percent," they said.

"If we suppose that, despite the 50-basis-point cut, the S&P were to decline toward 1300 by the end of this month, the model probability would remain unchanged from its current level (everything else being equal)," the Morgan Stanley analysts concluded.

The S&P 500 stock index .SPX rose 10.46 points to end at 1336.91 on Thursday.