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Trading Resumes In Bonds, Commodities

U.S. treasury securities rallied in light trading Thursday morning, pricing in another half-point rate cut by the Federal Reserve.

The bond and commodity markets were the first U.S. financial markets to reopen since Tuesday's massive terrorist attack destroyed the World Trade Center and damaged the Pentagon. The U.S. stock market remained closed for the third straight day for the first time since the Great Depression. The stock exchanges could open as soon as tomorrow, and NYSE chairman Richard Grasso said yesterday that they will be open Monday at the latest.

Trading in bonds and commodities was light, as many traders were unsure of market direction and the stability of the trading systems in light of key infrastructure lost in the World Trade Center attack. But after trading systems seemed to function well, volume picked up a little. The price of gold rose, as investors sought safe havens in bonds and gold.

Also this morning, the European Central Bank did not cut rates, contrary to expectations, but provided the banking system with another huge liquidity injection. European stock markets were mixed on the news. Asian markets were flat overnight following Wednesday's steep plunges. Asian economies depend heavily on exports to the U.S. market.

All eyes remained on the U.S. stock market, and most markets around the world appear to be waiting for the direction of U.S. stocks for their cue. Since the initial plunge on news of the U.S attack, volume in global markets has been light.

Analysts remain divided over what direction U.S. stocks will take when the market finally reopens. Many expect an initial sell-off or even a plunge, but some have suggested that U.S. stocks might even rally when they reopen.

The Federal Reserve and other market officials have taken extraordinary steps in an attempt to stabilize the market and the U.S. financial system. Record liquidity injections and restrictions of foreign trading in U.S. stocks and the dollar have been just two of the steps. The Fed and other world central banks have been working together in unprecedented cooperation. One SEC official said that U.S. companies may be allowed to buy their own stock, in effect putting a floor under the market.

There also appears to be a voluntary global effort to minimize damage to U.S. markets. Deutsche Bank reportedly has offered to handle trades of rival Citigroup. Many firms worldwide have reportedly limited short-selling and pledged not to sell when the U.S. stock market reopens. If these efforts hold, they bode well for the reopening of the U.S. stock exchanges.

But signs of the attack's financial devastation appeared this morning. S&P downgraded some airlines to credit watch negative, and reports of mounting insurance losses continued. Early estimates are for $25 billion in property damage, higher than the toll from Hurricane Andrew, likely making it the worst disaster in U.S. history. Also, Federal Reserve discount window borrowing has reportedly increased dramatically. It could just be nervousness on the part of banks, but since the Fed is essentially the lender of last resort, the borrowing shows at least a little strain on the financial system. The Fed has pledged to meet all liquidity needs, however, and has backed that up with by far the biggest liquidity injections ever.

For the U.S. economy, a short-term economic shock - from the loss of property and business and higher energy prices - appears certain. But the big unanswered question is the longer-term effect on the U.S. and global economy, particularly on already fragile consumer confidence. Many economists, the latest being Morgan Stanley's Andy Xie and Stephen Roach, predict that the shock will cause consumers to reign in spending even more, placing further strain on the U.S. and global economies.

Some economists think the attack will have little effect on consumers' psyche, and a few have even predicted that the crisis could be the spark that draws the U.S. economy out of its slump. But that view doesn't take into account the underlying problems that caused the U.S. slowdown to begin with: massive overinvestment and record personal and corporate debt. Those high debt levels had already prevented 300 basis points in Fed rate cuts from having much effect, and U.S. stocks had been in a steady 3 1/2-month downtrend before the attacks.

In the short-term, the stock market's initial reaction will probably be just that - a reaction. It will probably take at least a few weeks to get a sense of the tragedy's effect on the consumer. Consumer sentiment readings due out at the end of the month could give some indication; tomorrow's Michigan survey may not mean much in the scheme of things.

The stock market was deeply oversold and attempting to rally when the attack occurred; whether that rally continues is anyone's guess. One problem for the market is that two of the most economically sensitive sectors - transportation and financial stocks - will likely be hampered if not hurt by the disaster. The market's overall health may be dictated by the performance of those sectors when trading resumes.

One potential risk to the stock market is that some large institutions may already have been facing large losses in stock index futures before the attack. A further decline in the market between now and September 20 - the date that futures expire - could force some of these institutions to sell those futures positions, exacerbating any decline. This could be an additional reason for the Fed's massive support efforts.

But until the picture becomes clearer, the best advice seems to be the one that Wall Street firms have been preaching: Don't do anything until the market stabilizes.

And finally, something needs to be said about the extraordinary heroism in the wake of unspeakable tragedy. The hundreds of missing New York City firemen and policemen are at the top of that list. As is this heroic tale from today's Washington Post about the crash of United Airlines Flight 93 near Pittsburgh: http://www.washingtonpost.com/wp-dyn/articles/A14344-2001Sep11.html