LIBOR Down Again

LIBOR fell in all major currencies across all maturities at this morning's setting, the eighth consecutive decline. Dollar-based LIBOR fell the most, by 29 basis points for three-month LIBOR, which fell to 3.54%. The drop marks a 63% reversal of the sharp widening that occurred beginning on Sept. 16, which was in the immediate aftermath of Lehman's failure.

Three-month LIBOR peaked at 4.81875 on Oct. 10. Its spread to fed funds is now 204 basis points, its narrowest since Sept. 30. A 50-basis-point cut in the funds rate looks likely (the market is priced for 80% odds of such), which leaves room for LIBOR to fall much further from current levels.

Three-month LIBOR before the crisis tended to be 12.5 to 25 basis points over the fed funds rate. In recent times, in the months before Sept. 16, three-month LIBOR traded at about 80 basis points over the funds rate, the new norm, reflecting the dearth of capital in the banking system and an increase in risk premiums. A spread of 100 basis points could be viewed as normal for the balance of 2008 in light of current anxieties and yearend pressures, which this year will be greater than normal because of portfolio liquidations.

I have cited since last Wednesday a key factor that looked likely to break the logjam in the interbank market, chiefly the new tender offerings by the European Central Bank, the Bank of England, and the Swiss National Bank for dollar funding. Whereas these central banks previously offered fixed dollar amounts that were far below demand (as can be assumed from coverage ratios), the central banks began last Wednesday to offer an unlimited supply of dollars. To wit, $250 billion was lent in the seven-day maturity last week. Yesterday, the ECB, the BOE, and the SNB offered 28-day loans (the ECB lent $101.9 billion) and on Nov. 3 the central banks will offer 84-day loans. These auctions are helping to sate the needs of the international banking system.

The Federal Reserve's backstopping of money market funds and the commercial paper market are also having a major effect, ahead of the start of key programs such as the CPFF (Commercial Paper Funding Facility) and the MMIFF (Money Market Investor Funding Facility). These programs will reduce the migration by corporations to the banking sector, to which the corporate sector has had to turn because of dysfunction in the capital markets. By cutting the corporate sector's reliance upon banks for capital, more money will be made available for lending in the interbank market than would otherwise be the case.

ALL TONY CRESCENZI BLOG ENTRIES | POST A COMMENT | READ COMMENTS  

---

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.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.