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LIBOR and spreads between short term and long term rates came in flat yesterday as the markets waited for PPI and CPI for cues. This morning’s PPI was deflationary, so US short rates continue to come in nominally, but three month LIBOR is holding at 2.22% On the margin, this is a bearish signal for equities and a negative sign for liquidity in general as the cost of lending in the interbank and capital markets increases slightly on concerns over counterparty risk (the low was closer to 2.10%, so we are moving up from the lows, not down from them).

The decline of 3 month LIBOR from near 5% in early October to less than half of that in the first week of this month was one of the most positive signals in our macro model, but don’t mistake lower reference rates with increased liquidity. Figures released last week by the Fed for Interbank loans by commercial banks during the first week of November showed the second sequential week over week decline (see chart) suggesting that commercial lenders are still reluctant to extend credit despite government intervention. They fear the market’s proverbial pirates. They are sitting on their cash.

Meanwhile the swap spread market still reflects the high cost of financing positions in the capital markets. Although shorter maturity swap rates decreased overnight the levels still remain over 100 basis points – well above historic averages. The drought appears to be impacting the listed futures markets as well - an informal survey of brokers suggests that FCMs on average are quoting rates above the Exchange minimum levels and that this premium has been creeping up steadily in recent weeks.

We will continue to watch reference rates for signals, but will weigh those signals against the real cost of liquidity when factoring them into our model.

Andrew Barber
Director