Signs of thaw in credit markets are few

By The Associated Press

Published: October 8, 2008

NEW YORK - The squeezed credit markets saw just a few hints of loosening on Wednesday after the Federal Reserve slashed the target fed funds rate by a half-point to 1.5 percent.

The Fed also reduced its emergency lending rate to banks by half a percentage point to 1.75 percent, and raised the limit that primary-dealer banks can borrow in securities from the Fed to $5 billion from $4 billion. The Treasury Department, meanwhile, said it will increase the amount of Treasury securities being sold to the public.

It's possible the government's efforts will just take time to work their way through the distressed financial system before lending significantly loosens up again.

"These credit market conditions did not happen overnight, and it's not going to be resolved in one night, either," said Robert Dye, senior economist for PNC Financial Services Group.

But market participants are nervous. Moody's Investors Service said it sees credit defaults by the world's riskiest corporate borrowers spiking over the next year, which could make lending an even less attractive enterprise.

And raising capital remains difficult for banks — even Bank of America Corp., one of the stronger U.S. banks right now, had a disappointing stock sale Tuesday.

"If banks could find an effective means of raising capital ... they'd start to loosen up on credit. But if you don't know if you can raise capital, you can't afford to make a bad loan. The capital issue has to be solved first," said Kevin Giddis, managing director of fixed income at Morgan Keegan.

To be sure, the credit markets haven't been spiraling into a deeper freeze over the past week, which is a positive sign. In fact, a few corners of the credit markets have improved a bit.

Rates for 30-day commercial paper, for example, fell by about 0.20 to 0.40 percentage points by early Wednesday after the Fed said Tuesday it would start buying top-tier commercial paper, Giddis noted.

Commercial paper is the unsecured short-term debt that companies sell for their immediate cash needs, such as maintaining inventories and payroll. The biggest buyers have tended to be money market funds — but those funds have recently been flocking to Treasurys instead, because they're worried about companies failing, as Lehman Brothers Holdings Inc. did.

And Tony Crescenzi of Miller Tabak & Co. in a note pointed to a drop in the 10-year swap rate — an indicator of worries about credit spreads. If the 2-year swap rate follows suit, he said, it would "strongly signal an easing of pressures in the inter-bank market." He said another encouraging sign was Fannie Mae's Wednesday auction of Treasury bills, which garnered lower rates than two weeks ago.

Still, lending between banks remains expensive. The cut in the target fed funds rate could pull bank-to-bank lending rates back down, but no one is betting on them returning to normal levels anytime soon.

The London Interbank Offered Rate, or LIBOR, for overnight dollar loans jumped to 5.38 percent from 3.94 percent on Tuesday. For three-month dollar loans, LIBOR rose to 4.52 percent from 4.29 percent Tuesday. A month ago, three-month LIBOR was at 2.81 percent — this rise is important because many consumer loans, including adjustable-rate mortgages, are tied to LIBOR.

The yield on the three-month Treasury bill, regarded as the ultimate safe asset, dipped to 0.75 percent from 0.81 percent late Tuesday.

Longer-term Treasurys fell after the rate cut, while the Dow Jones industrial average was again down sharply.

The 2-year note fell 5/32 to 100 27/32 and yielded 1.55 percent, up from 1.47 percent late Tuesday. The 10-year note fell 1 5/32 to 102 28/32 and yielded 3.65 percent, down from 3.51 percent. The 30-year bond fell 4/32 to 107 24/32 and yielded 4.04 percent, the same as late Tuesday.

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