Both U.S. equity and bond markets want to price in an economic recovery.  There is a steady push in the financial media for the “green shoots’ argument, that recovery is actually starting, with a rising tide to lift the boats in the second half of the year and into 2010.  This has been accompanied by a steady grinding-in of the IG12 from over the 230 bps in March to a little under 150 bps at the end of May.  Accompanying this spread-tightening exercise has been a substantial wave of corporate issuance, which looks set to continue through June and maybe into July.  Is recovery around the corner?

While we would like to say yes, there are too many speed-bumps ahead that will make any recovery slower-than-expected – and disappointing to the market.  Among the speed-bumps ahead are more bank failures (related to higher credit card delinquencies and mortgage defaults caused by higher unemployment feeding into the prime loan area), an ongoing shift from a consumer-driven America to a more saver-driven national economy (meaning less money being spent), and higher taxes both from a federal and state governments to pay for everything from health care reform to bailing out the banks.

In addition, there is growing talk of the state level seeking new money from the federal level.  California is already asking for help from the Treasury’s TARP (Troubled Asset Relief Program) to be used to help back more than $13 billion in short-term borrowings.  There is also talk that Representative Barney Frank, chairman of the House Financial Services Committee, is drafting legislation that would have the Federal Reserve, and possibly the Treasury, stand behind floating-rate municipal bonds, a $400 billion market that provides short-term financing to municipalities, but has been frozen in the current credit crunch.