Although the stock market has taken considerable cheer from the monumental action by central banks to try to restore interbank lending to something resembling normalcy, the results to date have been meager. However, hope remains that improvement will continue, albeit at a slow pace.
From the Financial Times:
The costs for banks to borrow money from each other remain at highly elevated levels in spite of the global government action taken to cure the paralysis at the heart of the financial system…
Analysts said that while stock markets had rallied and the cost of protecting bank debt against default had tumbled by record amounts in the US, it would take time for the reduced costs of what is in effect government-sponsored funding to show through.
Three-month Libor, the most important interbank lending rate that is used to price loans, derivatives and many other kinds of financial products, has barely moved in sterling markets, which have had full details of the UK government guarantee since Monday morning.
Sterling three-month Libor was just 2 basis points lower at about 6.25 per cent, more than 2 percentage points above where markets are pricing UK interest rates and higher than where the rate set before last week’s co-ordinated interest rate cuts by major economies.
Similarly, euro three-month Libor, which was down 7.37bp at 5.225 per cent on Tuesday remains high.
“The fact that the boldest banking guarantee in history was not worth more . . . raised some eyebrows,” said Christoph Rieger, analyst at Dresdner Kleinwort.
Dollar three-month Libor is reacting better, down 11.75bp at 4.635 per cent, which was accompanied by a 15bp rise in the yield on three-month Treasury bills to 0.4 per cent.
This leaves the so-called Ted spread, which measures the difference between interbank lending rates and risk-free government lending rates, at a hefty 420bp. “These developments suggest that the market is reducing the odds of imminent financial Armageddon, but that significant year-end funding issues remain,” said TJ Marta, strategist at RBC Capital Markets.
Lou Crandall, economist at Wrightson Icap, said: “Heightened concerns about counterparty risk may have been the major reason for the initial pullback from the term money markets last month, but investors’ worries about their own liquidity exposure could make them slow to [return].”
An explanation for this conundrum may come from Nouriel Roubini via Bloomberg (hat tip reader Dwight):
Roubini said total credit losses resulting from the meltdown of the subprime mortgage market will be “closer to $3 trillion,” up from his previous estimate of $1 trillion to $2 trillion. The International Monetary Fund estimated $1.4 trillion on Oct. 7. Financial firms have so far reported $637 billion in losses, according to data compiled by Bloomberg
If you take Roubini’s forecast to heart, we are less than a quarter of the way through this crisis, but even based on the less alarming IMF forecast, we have yet to reach the half-way point.