Key Lending Rates Drop Amid Hope Worst Is Over

Global interbank lending rates fell sharply Monday, fueling hopes that central banks have succeeded in their massive efforts to unlock credit for cash-strapped banks and borrowers.

Other measures of stress in credit markets ebbed to levels not seen in more than a month, prior to a worldwide rescue of the financial system whose foundation was shaken in the wake of the bankruptcy of Lehman Brothers .

U.S. Federal Chairman Ben Bernanke said he was encouraged by the nascent improvement in credit conditions that was due to measures to shore up the banking system and to ensure liquidity in certain securities like commercial paper.

But it was too soon to conclude on their full impact, he told a Congressional panel.

Traders were guardedly optimistic, saying the jury was still out on whether authorities have successfully navigated the credit market through the worst of the crisis.

"We are still seeing a lot of difficulties to get through before we are out of the woods," said Martin Mitchell, head of government trading at Stifel Nicolaus & Co. in Baltimore, Maryland.

"We are still concerned about Wall Street and consumers finding financing." Governments around the world have pledged about $3.3 trillion—about equal to the economic output of Germany—aimed at boosting interbank lending and shoring up their economies amid the global credit crisis.

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Money markets plunged into near-chaos a month ago, contributing to U.S. and European governments' taking over part or all of some banks and financial companies.

However, credit availability appeared to be on the increase recently.

Encouraged by better credit conditions, traders shifted money to stocks and riskier investments from cash and low-risk U.S government bills.

The move sent Treasury bill rates to their highest in about a month and demand for new six-month bills to its weakest since April.

Falling Rates

Less jittery banks charged each other less for dollars in the unsecured lending market.

The London interbank offered rate for overnight dollars fell to a 4-year low, drifting closer to the Fed's target federal funds rate of 1.5 percent.

Traders widely expect the Fed to trim its target rate on overnight loans of surplus reserves between U.S. banks by at least another quarter percentage point after its two-day policy meeting next week.

More telling about a credit thaw was the plunge in longer rates suggesting banks grew more comfortable about lending rather than just hoarding cash.

The three-month Libor fell to 4.05875 percent, down 0.36 percentage point from Friday—the biggest one-day drop since late January.

Its spread over the expected three-month rate on the Fed's policy target rate, a closely watched gauge of credit jitters, contracted below 300 basis points.

At the height of the crisis earlier this month the spread was around 370 basis points.

Traders said a key catalyst for the drop in Libor rates on Monday was one large U.S. bank lending up to $20 billion in one-month dollar funds, pushing one-month interbank rates below 4 percent from around 5 percent.

The Wall Street Journal reported late on Friday JP Morgan led three U.S. banks pumping dollars into the system for European counterparts to access.

A particularly acute shortage of dollars in European and Asian trading hours since the collapse of Lehman Brothers in mid-September exacerbated the global credit crunch as banks hoarded dollars to bolster their own balance sheets rather than take the risk of lending it out.

Credits Elsewhere

More lending in the critical interbank market has spread to other credit areas.

The $1.5 trillion U.S. commercial paper sector has improved, as creditworthy companies can raise money by selling these short-term IOUs at rates below the interbank market.

Overnight rates on unsecured CP dropped below 1 percent on Friday, while 30-year unsecured CP rates averaged as low as 1.43 percent, according to Fed data released Monday.

More help is on the way in the CP market, where many companies had relied on funds for their day-to-day operations.

The Fed will launch its program to buy high-quality CP next Monday.

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