Markets soar as bail-out plan hangs in balance

Optimism that the $700bn bail-out of the financial system could be close to winning agreement in Congress sent stock markets soaring and eased pressures in the credit markets yesterday, even though politicians continued to haggle over details.

The unequivocal verdict of the market – that a deal would be a good thing, if not vital for the stability of the financial system – added to the considerable pressure on the negotiators.

Before a White House meeting broke up without the announcement of an agreement, the renewed optimism allowed traders to look through the latest grim news from the US economy. Data included disappointing unemployment and housing market figures, suggesting the credit crisis is already causing damage to the real economy.

The FTSE 100 closed up 101 points at 5,197, while hopes for a deal between the Treasury and congressional leaders were rising. Later, lawmaker comments that a deal had been agreed in principle saw the Dow Jones Industrial Average rise almost 2 per cent. Yields on US bonds soared as traders reversed earlier moves into safe haven holdings, with the yield on the benchmark 10-year bond jumping to 3.86 per cent, while one-month Treasury bills, which had seen an influx of worried investors earlier in the week, leapt by a massive 39 basis points.

Deeper in the battered credit markets, conditions remained more mixed. Three-month Libor – the rate at which banks are willing to lend to each other – had earlier in the day jumped 29 basis points to 3.769 per cent, the highest level since January, according to the British Bankers' Association. But swap spreads, a measure crucial to the cost of short-term borrowing for companies, reduced a little.

Traders are looking to the US government's plan to buy toxic mortgage assets from Wall Street to free up banks to begin lending again, even as new data showed the gathering clouds over the economy.

Perhaps the most closely watched of yesterday's data was the August sales of new homes, which slumped 11.5 per cent to their lowest level in 17 years, because of soaring foreclosures and continued bank restrictions on who can take out a mortgage.

That came as a blow to economists who had been hoping to see at least stabilisation in the US housing market, which is at the root of the financial chaos that has engulfed global markets. Sales of 460,000, calculated at an annual rate, were some 60,000 fewer than had been predicted. The average selling price was also disappointing, coming in at $221,900, down 6 per cent on the same time last year.

Until there is some stabilisation in the housing market, it will be impossible to judge the value of trillions of dollars of mortgage-related derivatives which are sitting on bank balance sheets and draining confidence from the banking system. Investors have so far written off $500bn from the value of those holdings, and the US government is planning to spend $700bn buying them, in a bail-out plan aimed at establishing some clarity in the market.

US durable good orders showed a higher-than-expected 4.5 per cent decline in August. Orders for non-defence capital goods excluding aircraft – a measure for business equipment spending, reflecting chief executives' confidence in the future – fell by 2.0 per cent last month, after having gone up 0.4 per cent in July.

And new unemployment claimsalso spiked higher, up 32,000 in thepast week, a much bigger rise thanexpected. The hurricanes along the south coast contributed to the rise.

Also yesterday, General Electric, the conglomerate seen as a bellwether of the US economy, issued its second profit warning of the year. Turmoil in global credit markets could drive profit down as much as 12 per cent this year, it said, confirming Wall Street's fears about the vulnerability of the company's finance arm.

Two of GE Capital's biggest businesses are loans to mid-sized companies and investments in commercial real estate. Both businesses have been hammered by the credit crunch, which complicates closing real estate deals, while the slowing economy raises the risk of default on some of its loans.

And after the closing bell, Research in Motion, maker of the Blackberry mobile phone beloved of corporate executives, warned that its profits later in the year will be below Wall Street hopes. Its shares dived 15 per cent in after-hours trading.