Concrete signs the Fed's move is working, a little

Posted by: Aaron Pressman on September 21, 2007

Northern Trust economist Asha Bangalore has a useful chart out today (PDF file) on the impact of the Federal Reserve’s rate cuts on Tuesday. Bangalore looked at three spreads that reveal the market’s stress level.

The most basic is the difference between the yield of 3-month U.S. Treasury bills and the yield on 3-month loans between banks as measured by the LIBOR index. Back in July, LIBOR was just 0.54 percentage points over the yield on Treasuries. In mid-August, the spread blew out and peaked at 2.41 points on August 20 as lenders feared the worst about ramifications and spillover from the subprime mortgage meltdown. Just ahead of the Fed’s meeting this week, the spread was still sitting at 1.75 points. Today, it’s down to 1.56 points.

A similar measure of financial system confidence is the spread between the yield on T-bills and the yield on commercial paper. That spread jumped from 0.43 percentage points to a peak of 2.15 points, also on August 20. A lot of commercial paper is backed by collateral consisting of financial assets, including subprime mortgages, as I discussed the other day, so this was another case of rampant paranoia due to subprime. The spread had closed to 1.54 points earlier this week and today stands at 1.41.

Finally, Bangalore compared the yield on Merrill Lynch’s junk bond index to the yield of the 10-year Treasury note. That measures the amount of extra yield investors want for the risk of owning junk bonds over super-safe paper backed by Uncle Sam. The spread jumped from 3.20 points to 4.71 points and had shrunk to 4.54 ahead of the Fed meeting. It’s at 4.11 points today.

Overall, there’s a bit of improvement, but not much. Certainly financial confidence is nowhere near its July level. Looks like Fed chairman Bernanke has a ways to go to reassure big lenders and investors that the system is healthy.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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