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Credit Crisis Watch: Has the Tide Turned?


The economy in pictures.

Are the various central bank-liquidity facilities and capital injections having the desired effect of unclogging credit markets and restoring confidence in the world's financial system? This is precisely what the Credit Crisis Watch is all about: a review of a number of measures in order to ascertain to what extent the thawing of credit markets is taking place.

First up is the LIBOR rate. This is the interest rate banks charge each other for one-month, 3-month, 6-month and one-year loans. LIBOR is an acronym for "London InterBank Offered Rate" and is the rate charged by London banks. This rate is then published and used as the benchmark for bank rates around the world.

Interbank lending rates -- the 3-month dollar, euro and sterling LIBOR rates -- declined to record lows last week, indicating the easing of strain in the financial system. After having peaked at 4.82% on October 10, the 3-month dollar LIBOR rate declined to 0.83% on Friday. LIBOR is therefore trading at 58 basis points above the upper band of the Fed's target range - a substantial improvement, but still high compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.

Importantly, US 3-month Treasury Bills have edged up after momentarily trading in negative territory in December as nervous investors "warehoused" their money while receiving no return. The fact that some safe-haven money has started coming out of the Treasury market is a good sign.

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The TED spread (i.e. 3-month dollar LIBOR less 3-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows.

Since the peak of the TED spread at 4.65% on October 10, the measure has eased to an 11-month low of 0.67% - still above the 38-point spread it averaged in the 12 months prior to the start of the crisis, but nevertheless a strong move in the right direction.

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The difference between the LIBOR rate and the overnight index swap (OIS) rate is another measure of credit-market stress.
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