TORONTO - Stock markets are in for a tense week after Friday's U.S. non-farms payroll report for August showed the first concrete signs that problems with beginnings in the subprime mortgage sector are spreading to the overall U.S. economy.
Stock markets racked up triple-digit losses at the end of the week after the U.S. Labour Department reported that instead of cranking out an expected 110,000 or so jobs last month, the economy actually lost four thousand jobs.
"And that will be the quandary for capital markets, especially for the stock markets, because the report does indicate the first kind of concrete evidence of the contagion from the capital markets into the real economy,'' said Patricia Croft, senior economist at Phillips, Hager and North.
It was the first monthly decline in employment since August, 2003 as problems that started with sharply rising defaults in the U.S. subprime mortgage sector morphed into a full-blown crisis on credit markets where liquidity has stalled, forcing central banks to intervene by injecting billions of dollars.
The report was a shock to investors who had taken in positive manufacturing, auto sales and retail numbers for August earlier in the week and came away with the impression that the economy had so far dodged the bullet from worsening credit conditions.
The employment data, made worse by sharp revisions to job creation numbers for June and July were revised down by a combined 81,000, raised fears that the United States could go into recession.
But at the same time, it raised hopes that the U.S. Federal Reserve will cut interest rates in order to boost confidence and raise liquidity at its next interest rate meeting Sept. 18 -- if not before.
The market is already trading on the assumption that there's a 75 per cent probability the Fed will make a 50-basis-point cut, "which is a pretty significant statement from the Fed,'' said Croft.
"But again there still is that whole issue out there of: Is the economy really in that much trouble and if the Fed does ease are they just bailing out entities that shouldn't be bailed out?''
Prior to Friday's losses, stock markets had shown a good deal of resilience since bottoming out in mid-August. But North American indexes are still well off earlier highs for the year.
But even now, the Toronto market and the Dow Jones industrials are still up around 5.5 per cent year to date.
"It's true, there has been a disconnect for some time -- the stock market has kind of shrugged off what's happening in the credit markets but that probably can't be avoided forever,'' said Croft.
"But I think part of the reason why equity markets have come back is the expectation that the Fed would cut rates and that there's lots of scope to do that and that it's not a recession, it's a slowdown and so equity markets are forward looking and they're looking forward to better times.''
Even so, those hopes were also based on hopes that gummed-up credit markets wouldn't affect the consumer. There are indications now that that's not the case.
"It's the past four weeks when things have started to change from a credit conditions standpoint and I'm one of these believers that credit constraints actually are more powerful to the economy than interest rates,'' said BMO Nesbitt Burns senior economist Michael Gregory.
"It's exceedingly difficult for (businesses) to finance in the money markets, consumers have seen a further collapse of the housing market and are finally seeing their banks (become) a little more reluctant, saying `You wanted to increase your line of credit. Well you know what? Instead of $50,000, we'll give you $25,000 -- that kind of a thing'.''
Last week's U.S. jobs report was in stark contrast to Canadian employment data for the month, showing better than expected job creation of 23,000.
That bolsters the hope that even if the U.S. slides into recession, Canada and the rest of the world don't have a lot to worry about because of strong economic growth.
Croft isn't so sure.
"Is the contagion from the U.S. spreading to the rest of the world? And the consensus so far has been that the U.S. can have its own problems and not affect anybody else. I'm not sure I necessarily agree with that,'' she said.
"Historically, the U.S. can go into recession and Canada doesn't -- but we still slow considerably. The links are still there.''
