Money Markets Still Stressed, Conditions Expected to Worsen

While the Fannie/Freddie crisis has come to the fore, the money markets continue to signal heightened worry about risk. Indeed, expert opinion and forward trading suggest that the year end crunch will be worse this year than last. Normally, liquidity starts to fall in December as banks start to square their books; last year, it started in November and became so acute that central banks intervened (the Term Auction Facility was one of the responses).

This Bloomberg story recaps current conditions and outlook:

“It’s like an ongoing nightmare and no one is sure when we’re going to wake up,” said [Stuart] Thomson, a money manager in Glasgow at Resolution, which oversees $46 billion in bonds. “Things are going to get worse before they get better.”

In a replay of the last four months of 2007, interest-rate derivatives imply that banks are becoming more hesitant to lend….The premium banks charge for lending short-term cash may approach the record levels set last year, based on trading in the forward markets…

“These problems going into year-end are likely to be worse this time round because of the amount banks have to refinance in December,” Thomson said, citing a figure of $88 billion. “The suspicion is that banks are still hiding losses. The banking system relies on trust and at the minute there quite simply isn’t any.”

Banks are charging each other a premium of 77 basis points over what traders predict the Federal Reserve’s daily effective federal funds rate will average over the next three months to lend cash. The spread is up from about 24 basis points in January, and may widen to 85 basis points, or 0.85 percentage point, by mid-December, prices in the forwards market show….

Increased turmoil in the money markets may again serve as a catalyst for a surprise year-end rally in Treasuries like the one in 2007…

A year ago, 10-year note yields fell about half a percentage point to 4 percent between September and December, even though the median estimate of 65 economists surveyed by Bloomberg was for a rise to 5 percent…

And just like last year, economists and strategists are again calling for an increase in yields. The median of 52 estimates in a Bloomberg survey between Aug. 1 and Aug. 8 was for 10-year Treasury yields to rise to 4 percent by the end of 2008…

Trust among banks remains low even after the Fed cut its target rate for overnight loans to 2 percent from 5.25 percent in September and created three emergency lending programs, including the Term Auction Facility, or TAF. In total, the Fed has provided almost $1 trillion of emergency loans.

The Fed’s most recent lending survey released Aug. 11 said that more banks tightened credit standards for consumers and business borrowers since April as defaults and delinquencies on home loans climbed.

“The problem is much more systemic than was widely anticipated a year ago,” said Michael Darda, chief economist for MKM Partners LLC in Greenwich, Connecticut. “Not only bank balance sheets but home balance sheets are under pressure due to falling house prices.”…

“Libor markets aren’t reflective of the entire banking system but of three or four major banks that continue to have pressure on liquidity,” said Saumil Parikh, a money manager who helps oversee $688 billion at Pacific Investment Management Co., in Newport Beach, California. “That spreads to the entire system because you are not really sure who you are going to end up lending to through the Libor market.”

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  1. Yves Smith

    The piece is not that well written. I think the point is Libor spreads vs, other benchmarks, not its absolute level. Although I don’t watch it, i have to imagine that Fed funds futures are trading lower because rate increase expectations have weakened. You’d expect Libor to move in sync. If it has stayed at more or less the same level, that would signal some nervousness.

    If FF futures are more or less the same as they were before oil prices broke, then I’d be puzzled too….

  2. chris

    Does the discussion about Libor snd other rates indicate that the financial world borrowed its way out of credit difficulties last year in the hope that lower interest rates would promote the activity which could “keep things going” for another round? Does this mean that what is coming up now, and for the rest of the year, (through the anniversary of the Fed’s help with year end book keeping) is that old debt, and last year’s borrowings need to be repaid, and new equity or debt raised to keep things going “forward”?

    If somewhat true, wouldn’t this surely indicate that all the wisdom, virtuosity and wit celebrated in Jackson’s Hole have only made “things” much, much worse.

    Or, is something else going on which the details are pointing to, but not making transparent?

    Debt roll-overs and pay-backs, in a timely way, do still seem to be key to the whole thing, borrow, pay interest on time, pay back what you borrowed on time, borrow more. Non-performance soon enough becomes default. The encore has to be international I guess.

  3. Hubert

    A shot from the hip: Banks lend according to LIBOR but only part of funding relates to LIBOR. So high LIBOR rates indicate trouble in the correponding Interbank Lending market but also bring much needed earnings margins.
    Now considering that the BBA makes up LIBOR anyway the way they want – and we certainly have found out that by now – isn´t it possible that they, by tacitly raising the 3 month rate, blackmail Central Banks into providing more cheap liquidity through the different Windows?
    2 weeks ago we could see LIBOR creeping up, new liquidity promised by CB´s, LIBOR rates falling 6-8 points only to go up again in the aftermath.
    Maybe it is just a replay of that maneuver.

    The banks have no longer any reputation to lose and if they put LIBOR up – what can CB´s do ?

    Be prepared for the next December funding panic: Give us a shot of cheap liquidity or we will push LIBOR.

    Am I too cynical here?

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