Are the various central bank liquidity facilities and capital injections having the desired effect of unclogging credit markets and restoring confidence in the world’s financial system? This is precisely what the “Credit Crisis Watch” is all about – a regular review of a number of measures in order to ascertain to what extent the thawing of credit markets is under way.
First up is the LIBOR rate. This is the interest rate banks charge each other for one-month, three-month, six-month and one-year loans. LIBOR is an acronym for “London InterBank Offered Rate” and is the rate charged by London banks. This rate is then published and used as the benchmark for bank rates around the world.
After having peaked on October 10 at 4.82%, the three-month dollar LIBOR rate declined sharply to 1.08% on January 14, but the healing process has since not made headway, with the current rate at 1.23%. LIBOR is therefore trading at 98 basis points above the upper band of the Fed’s target range – a great improvement, but still steep compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.
Source: StockCharts.com
Importantly, US three-month Treasury Bills have been heading higher, especially over the past few days, to 0.32% after momentarily trading in negative territory in December as nervous investors “warehoused” their money while receiving no return. The fact that some safe-haven money is now coming out of the Treasury market is a good sign.
US three-month Treasury Bill yield
Source: The Wall Street Journal
The TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows.
Since the TED spread’s peak of 4.65% on October 10, the measure has eased to a seven-month low of 0.91% – well above the 38-point spread it averaged in the 12 months prior to the start of the crisis, but nevertheless a strong move in the right direction.
Source: Fullermoney
The difference between the LIBOR rate and the overnight index swap (OIS) rate is another measure of credit market stress.
When the LIBOR-OIS spread increases, it indicates that banks believe the other banks they are lending to have a higher risk of defaulting on the loans, so they charge a higher interest rate to offset that risk. The opposite applies to a narrowing LIBOR-OIS spread.
Similar to the TED spread, the narrowing in the LIBOR-OIS spread since October is also a move in the right direction.
Source: Fullermoney
Despite the interbank lending rates having declined from their peaks, banks have significantly curtailed the amount of money they are actually lending. The US Depository Institutions Aggregate Excess Reserves continue their ascent at levels far in excess of the amount banks need to keep on deposit to meet their reserve requirements (see chart below). Although this measure recently started turning down, the level indicates that the balance sheets of banks remain under pressure, especially in view of the fact that the value of some assets is not known. As mentioned before, a definite peak in the Excess Reserves graph should coincide with a turning point in the recovery of banks.
Source: Fullermoney
