Morning Update

Unemployment Rate Holds, Wells to Buy Wachovia

Traders brushed aside a larger-than-expected drop in nonfarm payrolls and appeared relieved that the unemployment rate held at 6.1%, sending stocks higher. Shares are also receiving an assist from the news that Wells Fargo will acquire Wachovia in an all-stock deal that will not require FDIC assistance, leaving Citigroup, which had previously agreed to a buy the banking operations of Wachovia, out in the cold. Meanwhile, the Street will be closely watching the vote in the House of Representatives, which is scheduled for later today.

Payrolls disappoint

Nonfarm payrolls dropped 159,000 in September, the worst reading since March 2003 and below the Bloomberg forecast of a 105,000 decline. August was revised from a loss of 84,000 to a decline of 73,000, and July was left unrevised at a loss of 60,000. The unemployment rate held at 6.1%, matching the Street's forecast. Average hourly earnings increased 0.2%, below the forecast of 0.3%, and the year-over-year rate eased from 3.6% to 3.4%. Treasuries are mixed, with yields sharply higher at the short end of the curve.

The ISM Non-Manufacturing Composite Index will be released at 10:00 a.m. ET. The measure of activity for the service is expected drop dip from 50.6 in August to 50.0 in September. On Wednesday, the Institute for Supply Management surprised the Street when its manufacturing index reflected a sharp drop in activity. Nonetheless, most analysts are not expecting much of a change in the service sector. But if the credit crisis is not resolved quickly, the broad-based sector of the economy could soon run into major headwinds.

Tight credit markets

The three-month Libor Lending rate rose another 12 basis points to 4.33%, and the Libor-OIS spread, another measure of risk, widened to a record level, signaling that the freeze in credit markets continues to deepen. Banks are barely comfortable making overnight loans, and hundreds of billions of dollars of central bank injections have helped to bring the overnight lending rate back to more normal levels, but anything beyond just a few days is being shunned due to worries over liquidity.

Businesses depend on a banking system that functions normally. But when banks put their cash into T-bills instead of lending to firms, it stifles economic activity by cutting into business investment and hiring. Moreover, fears are rising that a lack of lending and problems in the commercial paper market may eventually claim a major company. But it is not just private firms that may falter. The LA Times reported that Gov. Arnold Schwarzenegger has sent a letter to US Treasury Secretary Henry Paulson asking the US government for a $7 billion loan if the credit crisis is not resolved soon. Neither the Treasury Department nor the governor's office commented.

Caution in Europe

European market have cut losses and are slightly higher in afternoon trading as traders cautiously eye dysfunctional credit markets and the vote on the $700 billion rescue plan that is scheduled today. Wells Fargo's decision to purchase Wachovia briefly aided the mood. Despite yesterday's plunge in US mining shares, the group is trading higher in Europe, while banks are up as UBS (UBS $20) extends gains amid expectations that it may have turned the corner following yesterday's news that it sees a small profit in 3Q. Shares of SAP (SAP $49), however, are falling after a brokerage downgrade of the world's largest maker of business software.

Though Europe has come off early lows, Russian stocks have resumed their slide and are down over 7% as trading was halted twice. Russia's invasion of Georgia, governmental meddling in the private sector, and rising risk aversion tied to the credit crisis have sent foreign investors running from the once high-flying market. Yesterday's sharp drop in crude prices added to skittishness about the economy.

Recession fears, US drop yesterday smack Asia

India's benchmark index lost 3.8% and Hong Kong closed down 2.9%, while Japan's Nikkei 225 Index shed nearly 2% and finished at a three-year low after US stocks slid sharply yesterday and fears grow that the major world economies are entering a recession. Even if the rescue plan is passed, the real economy in the US, Europe, and Japan remain in trouble, which is likely to produce more downside surprises.