Tuesday, October 7, 2008

Keep Your Eye on the Credit Markets’ Ball

Despite what you may hear in the media, the equity markets are the sideshow. It is the credit markets that hold center stage.

The table and chart below show the yields on various instruments and the TED spread (3 month LIBOR less 3 month US Treasury). When (not if) short term yields begin to rise in US Treasuries and decline elsewhere (specifically LIBOR), then an unfreezing of the credit markets will signal the beginning of the end of the credit panic.

While being mindful of the real economy and the risks of a deep recession, right now it is the credit markets where the focus needs to be placed.











sources: Yahoo! Finance, Bloomberg.com

8 comments:

Jeff said...

Hi Vinny,

First time to your blog and got the link from the NPR Planet Money Blog at http://www.npr.org/blogs/money/.

You mentioned that credit market is where we should look at. You further said that when the Treasury yield starts to rise and LIBOR start to drop, then we're nearing the end of the credit crisis tunnel. However, doesn't that mean that the TED spread will get bigger if this is the case? I observed that historically, TED spread has been about 0.5%, how can this be?

Jeff

Brian said...

I think it's the other way around. Since it's Libor over Treasury, as the yield on the tbills goes up and the interest on the libor goes down, the spread will go down.
IANAIB :)

Anonymous said...

First time viewer (also referred from Planet Money), but gotta Ph.D. and do science, so just need a handle on the jargon: what's LIBOR? Lending institution/instrument bank overnight rate? Something like that?

Vinny Catalano, CFA said...

LIBOR stands for London Interbank Offered Rate.

Here's a useful definition from Investopedia.com

LIBOR is "An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year."

Jeff said...

Brian,

Thanks for your comment. I get it now.
TED = LIBOR - 3 month Treasury Yield

Jeff

UnixChix said...

Hello,

I have a question, the 3 month yield closed at .007 on today, Friday 11/15/08. I recall you speaking with David Kestenbaum on NPR Planet Money, saying we should watch this indicator along with the TED Spread. If this 3 month yield dropped below 1, it was bad, so now that it is even lower, does this mean the world has begun its end? Should we all run out and buy generators? No, seriously?

Vinny Catalano, CFA said...

You want to look at both LIBOR (which tells you the lending environment between banks) and the 3 month US Treasury (which tells you how fearful investors are, the lower this yield (closer to zero) the more fearful investors are). The combination of the two - LIBOR minus 3 month US Treasury = the TED spread.

In normal economic and banking times, the TED spread averages 0.50%.

It has dropped considerably since the governments began pumping money into the banking system (from 4.5% (which is actually higher than you see in the chart above) to 2.10% which is where it is today, but nearly all of that drop is in LIBOR.

Investors are still very fearful and until that part of the equation gets better, the signs of economic stability remain in the future.

That said, no need to buy generators. Eventually, the heavy money inflow plus a reduction is selling pressure on hedge funds and mutual funds will help stabilize this enough to begin to build a stock market and economic recovery.

Don Sabatini said...

Nice blog.