Liquidity Markets Gain on the Fed's Move By Tony Crescenzi RealMoney.com Contributor 9/19/2007 9:32 AM EDT

Short-term liquidity markets, where problems in the credit markets have festered, have improved in the U.S. and abroad in the aftermath of the Fed's decision to lower the fed funds rate by 50 basis points.

The dollar-based London interbank offered rate (Libor), which measures the interest rate that banks charge each other for dollars invested abroad, has fallen 35 basis points for both one-month and three-month terms.

In the U.K., where there have been enormous strains in the banking system of late, sterling-based overnight Libor has fallen 26 basis points to 5.88%, a normal level given the Bank of England's 5.75% benchmark rate and 58 basis points lower than Monday's level. Sterling-based three-month Libor has fallen 20 basis points to 6.55%, 35 basis points below the recent peak. The decreases in Libor are important given the large amount of debts tied to Libor.

Swap rates are also lower, reflecting expectations for a narrowing of credit spreads. Swap rates reflect the interest rate at which debtors would swap their fixed-rate obligations for floating-rate obligations and vice versa. When debtors expect interest rates to fall and or credit spreads to tighten, they swap out of fixed-rate obligations and into floating-rate obligations, driving swap rates lower.

Improved conditions in the short-term liquidity markets are good for equities for obvious reasons, particularly because it means that the cost of borrowing is lower and, in the current environment, it indicates reduced strain in the credit markets.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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