Crescenzi on Debt Spreads: It Will Take Time
The yield spread between 3-month LIBOR and the fed funds rate is at its widest since 1987, reflecting continued funding strains in the inter-bank market and anxieties over the U.S. financial system in general. It is not surprising to see anxieties as high as they are given the magnitude of the current crisis, the history of reactions to previous crises, and plain old human behavior.
Concerns over whether Washington will pass the Treasury Department's proposal for purchasing up to $700 billion of distressed assets is the excuse given by most for the renewed strains in the financial markets, although it is difficult to fathom that investors truly believe Congress will fail to pass a bill this week. This means that the true driver of the continued strain in the money markets was last week's harrowing events and the impact it had on the psyche in the U.S. and around the world. Frayed nerves will eventually calm, as with past crises. (See more spread discussion in the video)
The yield spread between LIBOR and the fed funds rate, which for months was stuck at 80 basis points, today increased 1.375 basis points to 121.125 basis points, its widest spread since December 16th, 1987, which was two months after the stock market crash. That's a key point: it took two months before anxieties truly began to recover (the LIBOR/fed funds spread peaked at 206 basis points on October 19th, fell back to 31 basis points a few weeks later, and then widened steadily until early December before stabilizing for good).
In 1998 there was a similar pattern. The yield spread between LIBOR and the fed funds rate did not peak until November 17th, 1998, which was roughly three months after Russia's default and Long Term Capital Management's failure roiled markets. The TED spread, a fear gauge that measures the yield difference between Eurodollar deposits and T-bill rates, took two months to peak after the summer's events.
It will take time for nerves to calm in light of recent events. So long as the fallout from last week's shock is contained, a recovery will eventually take hold. During this time, investors with steadier nerves than the consensus will win.
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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."