After a long slide, the commercial paper (CP) market appeared toperk up this summer. The amount of CP outstanding, which peaked at$2.2 trillion in 2007, hit a low of $1.042 trillion dollars thisJune, then rose some $70 billion over the next six weeks, to $1.1trillion. Optimists began to speculate that the downward trend wasover. But the Federal Reserve's data for the week ended Aug. 25showed the CP market had slipped about $25 billion, to $1.087trillion. Is the CP market signaling that the economy is dippingback into a recession?

Actually, it's a case of two steps forward, one step back, saysRobert Little, head of global short-term fixed-income originationat Bank of America Merrill Lynch. Despite the fluctuations, “themarket has stabilized,” he says. “We're not seeing [significant]contraction.”

Little cites several reasons for a positive view of the CPmarket. “First, as the outlook for the economy improves you'llstart to see a pickup in M&A and more companies using CP as abridge financing tool for acquisitions,” he says. “Secondly,companies will build more inventory and as a result there will be aneed to issue more short-term debt” to finance that inventory.

And now that the Fed is perceived to be on hold on interestrates for some time to come, high-quality corporations may chooseto fund in the commercial paper market rather than issue any morelonger-term debt since they're not concerned that the term debtmarket is going to move away from them, Little notes. Companies mayincrease their short-term or floating-rate borrowings to takeadvantage of the interest-rate environment, he says.

Still, this is not the commercial paper market of yesteryear,notes Capital Advisors Group's Lance Pan. The era of high-octane,off-balance-sheet special investment vehicles (SIVs) fueling theasset-backed commercial paper market is gone forever, given changesin the regulatory regime and the treatment of SIVs. “Balances inthe [asset-backed] area will continue to go down,” says Pan. “It'sthe banks' preference to let that business run down.”

Another lasting structural change is the increased preference ofmoney market funds for shorter paper–a shift driven by newSecurities and Exchange Commission rules on liquidity. “Ideally,corporations would like to issue 30-, 60- or 90-day paper,” saysBrian Kalish of the Association for Financial Professionals, ratherthan seeing their paper constantly roll over. He notes that so farin 2010, one- to four-day paper has comprised 74% ofnon-asset-backed commercial paper issuance, compared with just 60%in 2008. Companies have to satisfy investors, says Kalish. “Theappetite for the longer-days paper has gone away.”