Credit spreads still elevated; funding concerns remain
Credit-market conditions showed further signs of improvement Thursday, responding to the Federal Reserve’s decision to slash a key U.S. interest rate to 1% along with central banks’ moves to further flood money markets with dollars.
The London interbank offered rate, or Libor, for three-month dollar loans fell for a 14th consecutive day. And data released Thursday showed the commercial paper market, a crucial source of funding for corporations, grew for the first time in seven weeks.
But markets aren’t out of the woods yet, economists said, with abnormally high credit spreads stoking worries about corporations and households having access to credit.
‘You’ve still got mortgage spreads that are very high relative to where you would expect them to be given that short rates are as low as they are.’
“It’s definitely helped and you’re seeing a gradual improvement, but we’re still at pretty abnormal levels in terms of what’s happening at the short end and what’s happening at the long end as well,” said Russell Jones, head of fixed income and currency strategy at RBC Capital Markets.
The Libor dollar rate, which reflects what banks charge each other for short-term loans, fell to 3.19% from 3.42% on Wednesday. The overnight Libor rate also fell, retreating to 0.73% from 1.14%.
Libor and credit spreads that measure banks’ willingness to lend to each other spiked sharply higher following the collapse of Lehman Brothers in September. Banks opted to hoard cash rather than lend to each other, precipitated by worries about their own balance sheets as well as fears that other banks could go bust.
Three-month Libor peaked at 4.82% on Oct. 10.
What’s important is the Libor rate relative to the Fed’s benchmark federal funds rate. Before the credit crunch, three-month Libor would typically hold within half a percentage point or less of the target rate.
The spread between three-month Libor and overnight index swaps, closely watched as a gauge of tensions in wholesale funding markets, narrowed to 2.46 percentage points, down from around 2.58 points on Wednesday, news reports said. The Libor-OIS spread peaked at 3.66 percentage points on Oct. 10.
The Federal Reserve said the total amount of commercial paper outstanding rose by $1.5 billion to $1.55 trillion. The credit squeeze had caused the market to contract over recent weeks. The expansion comes after the Fed on Monday implemented a program designed to purchase 90-day commercial paper directly from issuers.
The data indicate a bottom in the commercial paper market is in place, said Tony Crescenzi, bond strategist at Miler Tabak & Co. In the past three days, the amount of commercial paper issued with maturities of more than 81 days rose sharply.
“This is good news for issuers, as it will relieve strains associated with having to issue more frequently,” Crescenzi wrote. “Issuers are now ‘locked in’ to funding and can go about the normal functioning of their businesses without having the burden of corporate finance hanging over their heads.”
But strains remain elsewhere.
“Financing conditions are still extremely challenging both for banks and for companies as well, and also for people who might be thinking about buying a house,” Jones said. “You’ve still got mortgage spreads that are very high relative to where you would expect them to be given that short rates are as low as they are.”
Indeed, U.S. mortgage rates rose this week, with the average 30-year fixed mortgage rate soaring to 6.77% from 6.32%, according to Bankrate.com’s weekly national survey.
The average 15-year fixed rate mortgage jumped to 6.46%, while the average jumbo 30-year fixed rate climbed to 7.95%. Adjustable mortgage rates were mixed, with the average one-year ARM dipping to 6.09% but the average 5/1 ARM increasing to 6.67%.