Commercial paper decline belies economic recovery

NEW YORK (Reuters) - The steady contraction of the key U.S. commercial paper market for short-term corporate borrowing suggests the much heralded economic recovery may still be a distant dream.

The IOUs that companies write for periods of three months or less, known as commercial paper, enable funds to be raised for running businesses on a day to day basis to pay workers and stock shelves with fresh goods.

The decline in borrowing by corporations in this market in the past year reflects weak demand in the economy as a whole, meaning there is little need for companies to borrow to build up stocks or take on extra staff.

The labor market is still languishing, even if the pace of job losses is slowing slightly. Consumer confidence surveys are recovering from the depths of despair seen last year, but U.S. consumers have yet to put their money where their mouth is.

Companies usually borrow in the commercial paper market to rebuild inventories in anticipation of rising sales, but sales have fallen even faster.

“That shows there is a long way to go,” said Robert C. King an economist at the Jerome Levy Forecasting Center in Mount Kisco, New York. “Although eventually inventories will get down to some point where they will have to be rebuilt, we are not there yet.”

“That could be some explanation for the commercial paper market (trends) because it is used to finance inventories,” King said.

The latest weekly Federal Reserve data released on Thursday showed the commercial paper market’s dramatic contraction which began when the global credit crunch erupted in mid-2007 has continued unabated.

Total U.S. commercial paper outstanding has shrunk to $1.23 trillion, the lowest level in more than eight years and close to half its $2.2 trillion peak nearly two years ago.

The contraction in the commercial paper market suggests inventories may not have bottomed.

U.S. business inventories have been declining since the autumn of 2008 and fell again in the latest data for April this year.


To be sure, the U.S. government’s emergency programs to rescue the financial system have provided many other avenues for companies to borrow, contributing to commercial paper’s contraction.

Also many companies are borrowing longer term via the resurgent corporate bond market, which has rallied spectacularly so far this year.

Some big buyers of commercial paper have also made a permanent exit, denting demand.

“The market isn’t as broad as it was before,” said Leonard Santow, managing director of economic and financial consulting firm Griggs & Santow in New York.

Demand for commercial paper waned in the global financial crisis as money market funds and other big buyers shied away from these riskier securities, fearing that issuing companies and banks might collapse and fail to pay back loans.

The credit storm sank many structured investment vehicles (SIVs), which held between $350 billion and $400 billion of U.S. commercial paper.

The demise of the SIVs was one reason why the market shrank so fast from late 2007 through early 2008, said Deborah Cunningham, chief investment officer for taxable money markets with Federated Investors in Pittsburgh, Pennsylvania.

The Federal Reserve’s intervention in late 2008 to buy a huge slice of the commercial paper market has put a floor under prices but failed to stop its rapid contraction.

A struggling economy is still the main dynamic behind activity in commercial paper, analysts said.

“It is a lot better than it was, but it is still not a normal market, when you have a weak economy and you are liquidating inventory,” Santow said.

Should the market’s erosion stop, that would be one hint that the economy was bottoming out, analysts add.

“We need to look for a turn in indicators such as commercial paper to indicate an upturn in business needs, but we haven’t seen a need in companies to increase their working capital just yet,” said Dan Greenhaus, analyst in the strategy group with Miller Tabak + Co in New York.

Reporting by John Parry