Mish,

I use the year-over-year change in the Fed Funds rate to forecast real durable goods consumer spending since there is a nice correlation between the two. So I was interested in your comments about the spread between the Fed Funds rate and 1-mo LIBOR.

You mentioned the current spread of 75 basis points was a shock to our financial system. But, since 1986 the average spread between the two rates is about 60 basis points. Spreads between 1986 and 1991 were much higher than the average, the average spread was lower throughout the 1990s and even lower in the 2000s.

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While the current spread is higher than it has been for most of this decade, it’s not that high historically. So being relatively new to financial analysis and your blog I’m having a hard time seeing why this level of spread is such a concern? Perhaps, it is because rates are lower now than they were in the late 1980s and 1990s which makes the impact of the current spread much larger.

Your thoughts?
-Minyan SK

Minyan SK,

Thanks for the question. Perhaps the following charts will show things more clearly.

Three Month LIBOR Minus Treasury Bill Yield

Click to enlarge image

The above chart is from Michael Panzer at Financial Armageddon. The second chart is from Minyan JM who writes:

Mish,

I enjoy your stuff. I’ve been tracking rates on my own for the past decade and a half and I pulled the data on 1-month Libor spreads over Treasuries since you mentioned it in your column. It’s quite striking.

One Month LIBOR Minus Three Month Treasury Percentage Difference

Click to enlarge image

The above charts correspond to what I said in Deflationary Credit Downturn Is Underway, repeated here for convenience:

The interaction of M4, M3, the yield curve, and LIBOR both in the US and abroad are signs of an impending major market dislocation or bank failure of some kind. If this stress in not alleviated soon, we will literally be in crash conditions.

On the other hand, if these conditions, most importantly LIBOR, temporarily return to normal, perhaps we have a Santa rally. Regardless of what happens in December, the problems are too many and to severe to be permanently fixed by anything other than a major recession and deflationary writedown of debt.

Right now there is a big disconnect between the equity markets and the credit markets. This is not a stable situation. Perhaps we have a hint of what December will bring, given a rare November stock market decline and a negative start to December.

But regardless of how December concludes, the current conditions are not going to be resolved by a 50 basis point cut or even a 100 basis point cut by the Fed. We are facing solvency problems, not liquidity problems.

The ability of consumers and businesses to take on credit has been stretched to the limit regardless of what the interest rate is.