Fisher Investments Editorial Staff
Interest Rates, Investor Sentiment

LIBOR and TED’s Bogus Journey

By, 05/25/2010

Story Highlights:

  • LIBOR and the TED spread spiked dramatically during the peak of 2008's credit crisis, but slowly declined to historic lows—now, they're inching up again.
  • Some fear the upticks in the interbank borrowing rates and spreads could be an indication European sovereign debt issues could seriously impact banks worldwide and possibly lock up credit markets, precipitating another financial crisis.
  • Though higher than the extraordinarily low levels seen in recent months, both are far lower than levels reached during the peak of the financial crisis.
  • Overall, the global financial system is on much steadier footing and institutions are better capitalized to weather some volatility in short-term rates.
  • Additionally, central banks worldwide recently demonstrated they're poised to inject liquidity into economies to keep credit flowing.

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The London Interbank Offered Rate (LIBOR) and TED spread are two closely watched indicators signaling perceived bank credit risk. Both spiked dramatically during the peak of 2008's credit crisis, but slowly declined as fears of a financial system collapse, widespread bank nationalizations, and another Great Depression abated. Now, they're inching up again, leading investors to wonder if a credit crisis sequel—one set in Europe—is in the works.

Three-month US dollar LIBOR—or the rate banks charge each other for unsecured three-month USD loans—rose to its highest level since July 2009 on Monday. The TED spread—the difference between three-month LIBOR and "ultra-safe" US Treasury bill rates, or a measure of the extra premium banks pay to borrow—also widened lately. Not unnoticed by investors, these upticks are happening the same time European debt issues seem to be escalating.

Some fear the upticks in the interbank borrowing rates and spreads could be an indication European sovereign debt issues could seriously impact banks worldwide and possibly lock up credit markets, precipitating another financial crisis. But perspective is needed before declaring these rate rises signal another wild adventure for credit markets.

Despite the recent rise, the three-month USD LIBOR stands at just 0.51% as of Monday, and the TED spread is at 0.35%. Though higher than the extraordinarily low levels seen in recent months, LIBOR is within a rounding error of one quarter of one percent of December 2009's all-time low, and the TED spread is well within historic norms. Both are far lower than levels reached during the peak of the financial crisis when LIBOR jumped from 2.8% to 4.8% in just over a month, and the TED spread hit a whopping 4.6%!

Overall, the global financial system is on much steadier footing and institutions are better capitalized to weather some volatility in short-term rates. That doesn't mean select financial institutions won't run into trouble—Spanish regulators took over ailing CajaSur over the weekend because the local savings bank's board rejected a merger with a bigger bank as part of a country-wide restructuring plan. But as we've said, bank failures are common after a financial crisis and one or a handful of banks failing isn't necessarily symptomatic of something more alarming to come. For example, here in the US, the FDIC tagged 755 "problem" banks, but overall the banking system is healthy and turning in sound profits.

Additionally, central banks worldwide recently demonstrated they're poised to inject liquidity into the financial system to keep credit flowing. Just this weekend, the Bank of Japan (BoJ) announced a new credit facility for Japanese banks in hopes of boosting domestic loan growth, and the European Central Bank (ECB) purchased another €10 billion worth of European government bonds. All major central banks currently maintain exceptionally low interest rates and are coordinating efforts—earlier in the month, the Federal Reserve, Bank of England, Swiss National Bank, Bank of Canada, and BoJ reactivated dollar swap lines to ensure liquidity in US dollar funding markets.

The credit crisis is still relatively fresh in investors' minds, so it's not surprising each potential sign of strain in credit markets is scrutinized. But trying to extrapolate too much from something minor in the grander scheme of things could lead investors on a bogus journey.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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