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Crescenzi: Is Another Credit Crunch Here?

There was only a fractional increase in 3-Libor this morning, but there are indications that it will increase much more at tomorrow's setting, a reflection of renewed concerns about financial companies, falling asset prices, and the health of the global economy.

3-month LIBOR was set at 1.08563% this morning, up a smidge from yesterday's 1.0825%, its lowest level in 5-1/2 years. Near-month Eurodollar futures, which are highly correlated with Libor, indicate the possibility of an increase of at least 5 basis points at tomorrow's setting, and possibly 8 or 9 basis points. Moreover, Tullett Prebon's latest brokered quote on 3-month Libor also suggests an increase of about 5 or 6 basis points.

Swap rates are higher, yet another indication of an increase in fear with respect to credit spreads and variable rates such as Libor.

This concern was apparent in credit spreads yesterday, where Bloomberg data show investment-grade credit spreads having widened for the first time since December 5th. Bloomberg cites Merrill's U.S. Corporate Master Index, which widened 3 basis points yesterday to 560 basis points following a 99 basis point narrowing since December 5th.

The likelihood of a sharp increase in Libor is lower now than in September and October when Libor peaked.

The world's central banks have cut interest rates and expanded their balance sheets aggressively (the Fed's Commercial Paper Funding Facility has been particularly important in reducing the private sector's reliance upon scarce bank credit), the Fed is providing unlimited supplies of dollars to 14 of the world's central banks, and excess reserves in the U.S. banking system has increased sharply of late, to about $800 billion from near zero.

Nevertheless, Libor could rise in the short-run in response to worries about financial companies and weakening asset prices. When these fears subside Libor will likely resume its convergence toward benchmark rates, pushing 3-month dollar-based Libor below 1%.

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Tony Crescenzi
Tony Crescenzi

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."