Morning Update

Dazed and Confused

The squeeze in the credit markets continues and anxiety remains high as stocks have given up early gains and are lower after the Federal Reserve announced auction dates and avoided more aggressive action, including a coordinated rate cut among the world's central banks. Reserve Bank of Australia, however, did slash rates. In equity news, Bank of America posted much weaker profits, cut its dividend, and will raise capital, while Illinois Tool Works offered soft guidance. Traders will also be paying attention to comments from Fed Chief Ben Bernanke later this afternoon, and Alcoa will unofficially kick off 3Q earnings season after today's close. Treasures are slipping, and world markets are mixed.

Bernanke, credit markets in focus

Turmoil in the credit markets continues unabated, raising worries that the funding squeeze may claim a major company or require government intervention, whether here or abroad. The overnight Libor lending rate jumped from 2.37% to 3.94%, and the three-month Libor edged up 3 basis points to 4.32%. However, the two-year US swap spread, which is a measure of risk, is slightly lower.

Fed Chairman Ben Bernanke will address the National Association for Business Economics at 1:15 p.m. ET and will talk about the economic outlook and the financial markets. A question and answer session will follow his prepared remarks. How the Federal Reserve plans to help unthaw frozen credit markets, comments about the expected effectiveness of the Treasury's rescue plan, and the impact on the economy from the credit crisis are likely to grab the attention of traders. The Fed's minutes from the September 16 meeting will be out at 2:00 p.m. ET today.

Europe higher but worries remain

Stocks in Europe are rebounding following a plunge of more than 7% yesterday and are being led by a surge in shares of one of its leading automakers. Shares of Volkswagen (VLKAY $80) rose more than 50% in midday action as traders credited a short squeeze and a report that Porsche (POAHF $75) plans to increase its stake in the company from 35% to 50%. Neither company commented.

But much of the market remains under pressure from the ongoing turmoil in the credit markets. Royal Bank of Scotland (RBS $3) fell about 25% in early action after the Financial Times reported the bank had approached the UK government over a possible injection of capital. Shares of Barclays (BCS $23) also fell sharply amid worries the contagion was spreading, but the UK bank pared losses after its CEO said the company has not requested capital from the government and has "no reason to do so." The Wall Street Journal reported that several leading banks met with the UK's Treasury chief in an effort to come up with a plan to shore up capital, which is also hurting shares. RBS said that it has not requested capital from the government, but shares remain much lower.

Shares of SAP (SAP $40) are down over 10% after the world's largest maker of applications software said that the market developments of the past several weeks have been dramatic and worrying to businesses. SAP said that these concerns triggered a "very sudden and unexpected drop" in business activity at the end of the quarter. Meanwhile, Iceland, which is dealing with a full blown banking crisis, took control of the Landsbanki Islands, the country's second-largest bank. The government said the action was necessary in an attempt to stabilize the banking system and ensure deposits. Additionally, a report that Russia will loan the government 4 billion euros was denied by a Russian official.

Reserve Bank of Australia slashes rates

The Reserve Bank of Australia cut its cash rate by a full percentage point to 6.0%, well below the Bloomberg estimate of 6.50%. The bank said international financial markets took a "significant turn for the worst" last month and evidence is accumulating of a "significant moderation" in growth in Australia's trading partners in Asia. Notably, we will be closely looking for comments about demand from US multinationals that depend on sales in Asia. Nevertheless, traders are hoping that Australia's move is the beginning of a series of rate reductions, including the European Central Bank which has stubbornly resisted easing rates this year. Stocks in Australia jumped 1.7%.

The Nikkei 225 Index extended Monday's steep slide and fell another 3.0%, finishing at a five-year low after the yen soared against the world's major currencies yesterday. Shares of Toyota (TM $73) fell almost 5% on worries that the floundering US and European economies will pressure overseas sales, while the strengthening yen will cut into margins or lessen competitiveness. Sharp (SHCAY $8) lost nearly 10% after issuing a profit warning. Meanwhile, the Bank of Japan held its key rate at 0.50% as expected and noted that it is carefully watching financial markets and the economy is likely to remain stagnant for a while. Despite the growing risk to global growth, the BoJ took a more sanguine long-term view.