Liquidity -- Dismal April

US financial system liquidity declined in April, following several
months of modest but steady growth. Once again, the weakness
showed up in the financial services sector commercial paper market,
with outstandings falling $77 bil., or 4.7%. Banking sector interest
earning assets declined modestly on the tighter funding available.
This was no doubt disappointing for the Fed, which has again
expanded and broadened its direct lending to the sector via swaps.

Financial sector paper yields remained relatively elevated to go
along with the lower outstandings and so it appears there is ongoing
concern about valuing collateralized paper in a weaker economy,
especially within the depressed housing sector.

It appears that another $150 bil. of financial sector short paper
could come off before we see outstandings hit levels last seen back
in 2004, before the junk presses got rolling with a vengeance.
Likewise, the Fed has significant room to further expand its swap
lending programs before more pointed questions about the integrity
of its own balance sheet arise.

But, let's not minimize the problem here. Should the new pressures
on liquidity seen in April extend through the spring, the Fed will wind
up low on ammo, and other US Gov. measures may have to be brought
into play to stabilize these markets and allow the banks to resume
more normal operations.

Let me also note that Fed Bank Credit growth momentum slowed in
April, standing a puny 1.5% over the comparable level of a year ago.
Naturally, the Adjusted Monetary Base has also flattened out as a
consequence. From a liquidity perspective, monetary policy remains
tight and to some degree offsets the "ease" evident in the Fed Funds
Rate.

There is economic risk in this situation, so a resumption of liquidity
recovery will be an important factor over the next month or two.