Econ team sees more volatility, even tighter credit as central banks waiver. Amid a small avalanche of new bad news from (and about) some of the biggest names in finance, the Royal Bank of Scotland (RBS) is warning clients that things stand to get a lot worse this summer.

"A very nasty period is soon to be upon us -- be prepared," RBS' chief credit strategist Bob Janjuah and his colleagues write in a for-clients-only report, according to the U.K.'s Daily Telegraph newspaper.

The Edinburgh-based bank's report warns that equity and credit markets could crumble over the next three months while the big central banks -- hogtied by rising food- and energy-price inflation -- watch impotently from the sidelines.

Growling gets louder

After the benefits of the U.S. government's and the Federal Reserve's attempts to jumpstart the economy fizzle out in mid July, RBS sees the S&P 500 spiraling down to 1,050.00 by Labor Day, a drop of about 22% from its 1,342.83 close on 19 June 2008 and a 33% decline from its current 52-week high.

On the credit side, the Scottish bank says "the iTraxx index of high-grade corporate bonds could soar to 130/150 while the "Crossover" index of lower grade corporate bonds could reach 650/700 in a renewed bout of panic on the debt markets," according to the Telgraph.

In other words, RBS -- or at any rate one of its units -- sees the possibility of an already advanced investment and credit pullback morphing into one of the direst bear markets in a century.

RBS is keeping the report by its respected economic research team under wraps, saying it was never meant for general circulation. The Telegraph, which has a penchant for alarmism, seems to be the only media outlet to have seen the thing. This makes it hard to assess the report's full content or get a sense for its tone throughout.

The newspaper provides a couple of longer passages from the RBS report though, and here they are.

On the global economy

"Our macro economic road map is playing out: slow growth for longer, deep into 2009, with the pain spreading globally, gradually. People are beginning to wake up to the view that 2009 growth will be stagnant and weaker than 2008.

"The twist however is inflation, and in particular how central bankers deal with this stubborn problem. The worry is that the [European Central Bank] raises rates even as growth falters, leading to bigger cuts in 2009.

"In the U.S., policy paralysis is possible, whatever the Fed jaw-boning. And in Asia, uncertainty reigns. All in all, a poor backdrop for risk assets and a sure fire recipe for higher volatility."

On stocks and credit

"For risk assets, that downward revision to growth forecasts was something we expected to be translated into lower earnings estimates and higher forecasts of corporate defaults.

"We have repeatedly argued against getting bullish risk assets until this re-assessment has happened. The run-up in oil prices, and the policy response to that, adds a few twists.

"Thereafter I expect markets to attempt to go a little better over the very end of June and into July, but this will, I think, be a pretty feeble rally both in terms of size (50/70 S&P points) and time (2 to 4 weeks).

"What it will do however is set up what I think will be THE SIGNIFICANT opportunity this year to get short stocks and/or credit (credit will react to, and 'relatively' outperform stocks)."

The Telegraph says that RBS' Janjuah "became a City star after his grim warnings last year about the credit crisis proved all too accurate."

The "City" is London's financial district.

Bottom fishing

Meanwhile Morgan Stanley saw profits fall by 61% in the March quarter, the Wall Street investment bank reported this week. It blamed fallout from the credit crisis. Its result would have been worse were it not for a $698-million pretax gain from the sale of its Spanish wealth-management business and a $732-million take from selling 20 million shares of its index maker MSCI.

In another March-quarter report this week, Lehman Brothers, a firm that's been raising eyebrows since an inability to secure short-term credit choked its rival Bear Stearns nearly to death this past winter, reported a sharp -- though expected -- loss of $2.8 billion loss. It "wrote down" -- that is, wrote off -- $3.7 billion in evaporated assets in the quarter.

Now Citigroup is warning that it will probably make some "substantial" new write-downs on sub-prime securities and leveraged loans when it unveils its June-quarter numbers this summer.

And analysts at JPMorganChase say UBS is likely to write down another $4.8 billion in the second quarter on exposure to "monoline" bond issuers and a loss from a sale of assets to the investment-management firm BlackRock.

Banks and other financial institutions have written down more than $400 billion since the credit crunch started to hit home last autumn.

Part of UBS' problem is that its clients keep withdrawing assets -- to the tune of about $39 billion in Q2, according to JPMorgan. That's up from the $12.3 billion in first-quarter withdrawals that occasioned so much finger-wagging in the Swiss bank's direction a few weeks back. -FWR

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