Sickly Spain: Debt Downgrade Debacle

On news that Fitch's has downgraded Spain's debt rating, LIBOR has reversed and begun rising again. Eurodollar futures have accordingly reversed to the downside.Debt worries are back!

LIBOR Leaps, TED Spread Widens

LONDON (MarketWatch) -- The rate that banks charge each other for short-term loans in U.S. dollars hit another 10-month high Tuesday, underlining growing unease over the possibility that Europe's crisis in sovereign debt could turn into a banking crisis.

The three-month U.S. dollar London interbank offered rate, or Libor, was fixed at 0.53625%, up from Monday's 0.50969%, according to the British Bankers' Association. Tuesday's rate marked the highest level since early July and continues an uptrend that began in the spring.
Libor is the benchmark most widely used for short-term interest rates around the world.
The steady, ongoing rise in Libor and other key measures of tensions in the money markets were blamed for undermining sentiment in equity markets around the world Tuesday, reminding investors of the near-freeze in credit markets that threatened to shut down the global financial system in late 2008 in the wake of the collapse of Lehman Brothers.

No 2008 rerun

The recent rise is nowhere near the same scale and looks "quite muted" compared with the levels seen at the height of the financial crisis, acknowledged Elwin de Groot, fixed-income strategist at Rabobank in the Netherlands.
But it's also "quite clear that the situation is deteriorating day by day in a sense that it is becoming something to be worried about," he said.
Libor, which normally adheres closely to official interest-rate expectations, blew out to around 5% in 2008 even as the Federal Reserve was slashing its key rate from 2% toward zero. The spread between three-month dollar Libor and overnight index swaps, a key measure of the willingness of banks to lend to each other, soared to an extraordinary level of more than 360 basis points -- 3.6 percentage points.

By contrast, the spread between three-month dollar Libor and overnight index swaps, viewed as a gauge of how willing banks are to lend to each other, topped 30 basis points, or 0.3 percentage point, on Tuesday.
While far off the levels seen at the height of the crisis, it's still the highest reading since last summer and has served to undermine sentiment across financial and equity markets.

Costlier to borrow

Meanwhile, the TED spread, measuring the gap between the rate on three-month Treasury bills /quotes/comstock/31*!ust3mo (UST3MO 0.17, 0.00, 0.00%) and three-month Libor, jumped to 37.1 basis points, or 0.369 percentage point -- its highest level since July. The spread spiked in October 2008 to more than 460 basis points, according to FactSet Research.
In another sign of how costs are rising for companies needing to borrow funds, two-year swap spreads rose to 56 basis points, after touching the highest since May 2009.
A swap spread is the difference between the rates to exchange floating- for fixed-interest payments and comparable-maturity Treasury yields. Wider spreads mean banks are more hesitant to lend to each other, putting pressure on funding costs and, indirectly, the rates that homeowners and corporate lenders pay.
"The bottom line is that equity investors will continue to remain tentative until some level of stability emerges among these spreads," said Mike O'Rourke, chief market strategist at BTIG in Chicago.
At the same time, current levels show "we are not in a complete market meltdown and perhaps one can be avoided," wrote Greg Gibbs, an economist at Royal Bank of Scotland, in a strategy note.
But he also pointed out that confidence in the banking system "doesn't have to retreat too far to have a meaningful impact when markets and positions are coming off relatively optimistic levels."
And Libor doesn't tell the full story of funding costs, according to Gibbs.
Spanish banks, for instance, are presumably paying significant margins over Libor for short-term loans, he said.
Spain's banking woes have served to heighten tensions far beyond its borders. The Bank of Spain over the weekend moved to seize CajaSur, a troubled regional lender, or caja, and moved to consolidate other institutions. See European Stocks to Watch.
CajaSur's collapse was tied to its exposure to Spain's collapsed property bubble and highlighted worries about the strength of the nation's banking sector.

Libor Drop Paints Incomplete Picture

excerpt from FT.com:

However, analysts and bankers warn that Libor rates may not be telling the full story.

That is because there are wide differences between the rates at which individual banks can borrow. The biggest institutions are able to fund themselves at around Libor levels while smaller institutions have to pay, in some cases, more than 100 basis points above Libor. This is explained by continuing counterparty risk in what remains an uncertain economic environment.

That contrasts with the situation before the credit crisis when institutions paid similar rates to borrow.

Meyrick Chapman, fixed income strategist at UBS, says: “We should not build up our hopes that the fall in Libor is such a positive sign for the markets. We have a very tiered market, where many smaller banks are still having to pay relatively high rates to borrow.”

Lena Komileva, head of market economics at Tullett Prebon, adds: “What we are seeing is a huge difference in the price of borrowing for individual banks. There is a higher proportion of banks paying above Libor.”

The British Bankers’ Association, which sets Libor by compiling an average cost of lending from the 16 banks, defends the rate, stressing that the market understands it is a reference point for the strongest banks.

John Ewan, director at the BBA, says: “We use 16 banks to set the Libor rate. They are among the biggest banks in Europe. The market knows this and understands that other smaller banks may have to pay more. This is not a false signal to the markets.”

Some analysts also point out that a rate of 100bp above Libor is still very low on an historical basis. Libor rates are at record lows as they track central bank rates, which are close to zero in the US, 0.5 per cent in the UK and 1 per cent in the eurozone.

Central banks have helped the market, too, by providing vast amounts of liquidity in secured lending, where banks and institutions can raise money at low rates in exchange for collateral.

However, the higher rates the smaller institutions have to pay in the unsecured lending markets, which were the most flexible and easiest to access before the credit crisis, will slow recovery as the higher costs will act as a drag on their earnings and mean institutions will take longer to recapitalise. Institutions also face difficulties funding much further out than three months as banks are reluctant to lend beyond this period due to counterparty risks. And when they do so, it is at punitive rates.

At the same time, funding in the longer-term corporate bond markets is very expensive.

The bond markets, where bond funds and asset managers are the main lenders rather than the banks, may be open with issuance at record levels, but the costs for an investment grade company is nearly 200 basis points more than it was at the start of 2008.

The average rate for a triple-B rated company to issue bonds in dollars is 7.75 per cent compared with 5.92 per cent in January 2008, according to Merrill Lynch.

That forces many institutions to roll over their debt in the short-term markets, where maturities are typically no more than a month.

Significantly, this type of funding is likely to become more expensive as most analysts expect Libor rates to rise with official central bank rates unlikely to fall much lower.

Steven Major, head of global fixed income at HSBC, says: “Libor is very misleading. The published levels may be very low compared with recent history, but in reality I am not convinced much volume is going through beyond the one-month maturity. Furthermore, if institutions want to fix their debt over a longer term they have to pay enormous rates to do so.”

Gary Jenkins, head of fixed income research at Evolution, agrees: “The fall in Libor rates is not a great guide to what is happening in the overall economy. We are definitely in for a long haul. We won’t get back to a situation where banks are lending in the way they were before the credit crisis for a long, long time.”

Credit Crisis Watch from John Mauldin -- Signs of Improvement

from John Mauldin's Outside the Box, written by Dr. Prieur du Plessis:

Credit Crisis Watch: Thawing – noteworthy progress

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, three-month, six-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. The higher the LIBOR rate, the greater the stress on credit markets.

Interbank lending rates – the three-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 three-month dollar LIBOR rate declined to 0.66% on Friday. LIBOR is therefore trading at 41 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 three-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.

The TED spread (i.e. three-month dollar LIBOR less three-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 0.48%. This is a vast improvement, although still somewhat above the 38-point spread it averaged in the 12 months prior to the start of the crisis.

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

When the LIBOR-OIS spread increases, it indicates that banks believe the other banks they are lending to have a higher risk of defaulting on the loans, so they charge a higher interest rate to offset that risk. The opposite applies to a narrowing LIBOR-OIS spread.

Similar to the TED spread, the narrowing in the LIBOR-OIS spread since October is also a move in the right direction.

Further evidence that the convalescence process is on track comes in the form of data showing a sharp decline in borrowing by primary institutions at the discount window – down by almost 65% since the "panic peak" recorded during the week of October 29, 2008.

The Fed's Senior Loan Officer Opinion Survey of early May serves as an important barometer of confidence levels in credit markets. Asha Bangalore (Northern Trust) said: "The number of loan officers reporting a tightening of underwriting standards for commercial and industrial loans in the April survey was significantly smaller for large firms (39.6% versus peak of 83.6% in the fourth quarter) and small firms (42.3% versus peak of 74.5% in the fourth quarter) compared with the February survey and the peak readings of the fourth quarter of 2008."

"In the household sector, the demand for prime mortgage loans posted a jump, while that of non-traditional mortgages was less weak in the latest survey compared with the February survey. At the same time, mortgage underwriting standards were tighter for both prime and non-traditional mortgages in the April survey compared with the February survey," said Bangalore. In other words, more needs to be done by the lending institutions to revive mortgage lending.

The spreads between 10-year Fannie Mae and other Government-sponsored Enterprise (GSE) bonds and 10-year US Treasury Notes have compressed significantly since the highs in November. In the case of Fannie Mae, the spread plunged from 175 to 26 basis points at the beginning of May, but have since kicked up to 37 basis points on the back of the rise in Treasury yields.

After hitting a peak of 6.51% in July last year, there was a marked decline in the average rate for a US 30-year mortgage. However, the rise in the yields of longer-dated government bonds over the past nine weeks – 92 basis points in the case of US 10-year Treasury Notes – resulted in mortgage rates creeping higher since the April lows. Also, the lower interest rates are not being passed on to consumers, as seen from the 434 basis-point spread of the 30-year mortgage rate compared with the three-month dollar LIBOR rate. According to Bloomberg, this spread averaged 97 basis points during the 12 months preceding the crisis.

Fed Chairman Ben Bernanke said earlier in May that "mortgage credit is still relatively tight", as reported by Bloomberg. This raises the possibility that the Fed will boost its purchases of Treasuries to keep the cost of consumer borrowing from rising further. [The Fed has so far bought $95.7 billion of Treasury securities from $300 billion earmarked for this purpose. Similarly, purchases of agency debt of $71.5 (out of $200 billion) and mortgage-backed securities of $365.8 billion (out of $1.25 trillion) have taken place.]

As far as commercial paper is concerned, the A2/P2 spread measures the difference between A2/P2 (low-quality) and AA (high-quality) 30-day non-financial commercial paper. The spread has plunged to 48 basis points from almost 5% at the end of December.

Similarly, junk bond yields have also declined, as shown by the Merrill Lynch US High Yield Index. The Index dropped by 44.4% to 1,213 from its record high of 2,182 on December 15. This means the spread between high-yield debt and comparable US Treasuries was 1,213 basis points by the close of business on Friday. With the US 10-year Treasury Note yield at 3.45%, high-yield borrowers have to pay 15.58% per year to borrow money for a 10-year period. At these rates it remains practically impossible for companies with a less-than-perfect credit status to conduct business profitably.

Another indicator worth monitoring is the Barron's Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. There has been a solid improvement in the ratio since its all-time low in December, showing that bond investors are growing more confident and have started opting for more speculative bonds over high-grade bonds.

According to Markit, the cost of buying credit insurance for American, European, Japanese and other Asian companies has improved strongly since the peaks in November. This is illustrated by a significant narrowing of the spreads for the five-year credit derivative indices. By way of example, the graphs of the North American investment-grade and high-yield CDX Indices are shown below (the red line indicates the spread).

In summary, the past few months have seen impressive progress on the credit front, with a number of spreads having declined substantially since their "panic peaks". The TED spread (down to 0.48% from 4.65% on October 10), LIBOR-OIS spread (down to 0.45%% from 3.64% on October 10) and GSE mortgage spreads have all narrowed considerably since the record highs.

In addition, corporate bonds have seen a strong improvement, although high-yield spreads remain at elevated levels. Credit derivative indices for companies in all the major geographical regions have also shown a marked tightening since the November highs.

Most indications are that the credit market tide has turned on the back of the massive reflation efforts orchestrated by central banks worldwide and that the credit system has started thawing. However, although the convalescence process seems to be well on track, it still has a way to go before confidence in the world's financial system returns to more "normal" levels, liquidity starts to flow freely again, and the economic recovery can commence.

LIBOR Falls to Record for Recession

As LIBOR falls, the Eurodollar futures rise (see chart).

from Bloomberg:
The cost of borrowing in dollars between banks had its biggest two-day drop in more than four months amid confidence record low interest rates and a recovery among financial institutions is unlocking credit.

The London interbank offered rate, or Libor, for three- month dollar loans declined three basis points today to 0.75 percent, the British Bankers’ Association said, bringing its drop in the past two days to seven basis points, the most since Jan. 13. The rate has decreased in each of the past 35 days.

“The tension has disappeared and we are gradually normalizing,” said Patrick Jacq, a senior fixed-income strategist in Paris at BNP Paribas SA, the biggest French lender. “There’s less stress in the market and banks know they will get liquidity.”

The $33 Trillion Question

from Absolute Return Partners (quoted in John Mauldin's newsletter):

"Never in the history of the world has there been a situation so bad that the government can't make it worse."

-Unknown

Is the crisis really over?

Commercial paper spreads have come down dramatically. Libor rates are (hmm - almost) back to normal. Even high yield spreads are narrowing. It certainly appears as if the credit crisis is well and truly over or, at the very least, the light which most of us think we can see at the end of the tunnel is no longer that of an oncoming freight train.

No wonder equities are currently enjoying one of their best spells ever. And while equities continue to go up and up, most of us are left scratching our heads. Is this the real thing or will it go down in history as 'just' another bear market rally? Not so long ago, the entire financial system stared Armageddon in the face. Now, only a few months later, equity markets behave as if all the worries of yesterday have been washed away. How is that possible?

The great bank illusion

The current bull market began in earnest in the second week of March, but what really got everyone going were the surprisingly good Q1 US bank earnings which were reported during the first half of April. Most commentators interpreted the numbers as the clearest piece of evidence yet that we are now firmly on the road to recovery.

Of course US banks made good money in Q1. The environment created for them is the equivalent of the US government reducing the cost of goods to zero for its embattled car manufacturers and then going on to buy - courtesy of the US tax payer - a couple of million cars that nobody really needs. Even Detroit would make money given those conditions!

Liquidity is trapped

The problem for the rest of us is that the banks are not sharing the candy they have been handed. Much of the liquidity created by the central banks remains trapped in the financial sector (see chart 1). Quite simply, the multiplier is not doing its job, as many banks prefer to hoard cash rather than increase lending at this juncture.

This is both good and bad news at the same time. Good because it implies that we probably do not have to worry too much about the inflationary effect of the aggressive monetary easing currently taking place; bad because it means that the economy is not going to kick back to life as quickly as everyone would like – and expect.

Meanwhile investors are growing cautiously optimistic about the GDP outlook for the second half of the year with many now forecasting modest growth – at least in the United States. Only a fool would suggest that GDP would shrink by 5-10% per quarter in perpetuity, as has been the case over the past two quarters. The economic slowdown is now decelerating and, as I pointed out last month, there are good reasons why we may see a temporary lift in economic activity later this year, but it will almost certainly prove transitory.

We are still in a bear market

The dangerous conclusion to draw from the experience of the past few weeks is that all is now well and dandy and it is time to load up on stocks again. I cannot emphasize it strongly enough: The bull market of March-April 2009 is almost certainly a bear market rally but, as one of my partners pointed out the other day, NYSE saw four 20%+ rallies between 1929 and 1932 (see chart 2). Bear market rallies can be extremely powerful and hence deceiving.

The problems are not over yet. Not by a long stretch. It will take longer than 18 months to unwind the excesses of the past 25 years. Analysts at Morgan Stanley reckon that the 15 largest banks which between them have shrunk their balance sheets by about $3,600 billion so far in this crisis, will shed another $2,000 billion in 2009¹. If you do not share my pessimism, please take a quick look at chart 3 below. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off with total household debt now at 96% of GDP vs. 47% in 1982.

Further write-offs to come

The IMF reckons that both European and US banks - but in particular the European ones - are well behind the curve in terms of recognizing their credit crunch related losses. According to the IMF, there is at least another $1,500 billion to come. So when the US banks reported surprisingly good numbers for Q1 it was certainly not because the economy had suddenly and miraculously revived itself, but because some of the oldest tricks in the book were used to gloss over much bigger problems².

As the recession bites into the lives of ordinary people, banks will face losses not only on sub-prime mortgages but on all loan products. As you can see from chart 4, sub-prime is indeed a small fraction of the total loan book for the US banking sector.

Delinquencies are on the rise

And that is precisely what is beginning to happen as illustrated in chart 5. Delinquencies are now on the rise on all mortgage products; however, whereas sub-prime started to deteriorate as early as 2007, it is only recently that delinquencies related to Alt-A and adjustable rate mortgages have taken off, and prime and jumbo loans are only now starting to suffer.

These are all temporary problems, though, however bad they may appear. By far my biggest concern at the moment is the enormity of the debt problem facing most OECD countries. In the March issue of the Absolute Return Letter I referred to an important study conducted by Carmen Reinhart and Kenneth Rogoff back in December of last year³ which I would like to re-visit (see chart 6).

Banking crises run and run

Reinhart and Rogoff studied every banking crisis of the past generation and made some startling observations. One in particular caught my attention. It has to do with the subsequent rise in government debt which, according to Reinhart and Rogoff, has been "... a defining characteristic of the aftermath of banking crises for over a century". According to the authors, governments inevitably underestimate the ultimate cost of a banking crisis, because the indirect costs (such as falling tax revenue in subsequent years) end up much higher than predicted.

The IMF estimates that the cost of the current crisis to the United States will eventually reach 34% of GDP or close to $5 trillion. However, the Obama administration, through its various implicit and explicit guarantees, is already using a number close to $9 trillion⁴. And Reinhart and Rogoff's historical average of 86% of GDP implies an ultimate cost of over $12 trillion!

The IMF is too optimistic

I have a lot of respect for all the good work being produced by the people at the IMF; however, they are sometimes too politically correct for my taste; maybe too afraid of stepping on someone's toes. So when they go public, as they did recently, with an estimate of how much the current crisis would ultimately cost, their projection will more than likely prove hopelessly inadequate.

The true cost is important, because it has to be financed through new bond issuance, and it is my thesis that the sheer size of this tsunami will eventually overwhelm the world's bond markets. As you can see from chart 7, using the official IMF estimates, the twelve most industrialised of the world's G20 countries (in my book known as the Dirty Dozen) will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis.

The final cost will be enormous

However, if you (like me) believe that IMF underestimates the true cost of this crisis, Reinhart and Rogoff offer a more realistic approach (see chart 8). Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn't even bother to produce a worst case scenario - it all got too depressing!

I need to put the $33 trillion into perspective, because it is so big that it is almost incomprehensible. According to Wikipedia (see chart 9), total private wealth across the world today is about $37 trillion less the losses incurred in 2007-09, so the real number is probably closer to $30 trillion now. Total global savings (loosely adjusted for the big losses in 2008) are probably somewhere in the region of $100 trillion. In other words, financing this crisis could absorb one-third of total global savings. No wonder Gordon Brown looks tired!

Where do we find the money?

Obviously, governments may buy a portion of these bonds themselves, but they cannot afford more than a fraction of the total unless they want to challenge Mugabe as the ultimate master of illusion. Neither should investors hold out for sovereign wealth funds to do the dirty work. As is clear from chart 9, the total amount of wealth accumulated in these funds is pocket money when compared to the projected bond issuance over the next few years.

Hence it comes down to the price at which governments can attract sufficient demand from people like you and me. One of two things may happen. Either this crisis will ignite such a bout of deflation that investors will happily own government bonds yielding 2-3% or the deflation scare goes away ultimately, the global economy recovers and bond investors demand much higher yields for taking sovereign risk. I am not yet sure which scenario will prevail, but I do know that both are quite bad for equities longer term. Take your profits!

Niels C. Jensen

---

¹ "Doomsday is on hold but banks will still feel further pain", The Financial Times, 30^th April, 2009.

² In particular one US accounting rule change (FASB rule 160) explains a large part of Q1 profits.

³ "The Aftermath of Financial Crisis", Carmen Reinhart & Kenneth Rogoff, December 2009.

⁴ http://zerohedge.blogspot.com/2009/04/bail-out-for-dummies-part-1.html

Eurodollar Futures: Now That's Some Trend

Every day I expect this trend to reverse, or consolidate, especially since it is based upon interest rates for Libor. However, it just keeps going and going.

From Moneycafe.com:

LIBOR stands for "London Inter-Bank Offered Rate." It is based on rates that contributor banks in London offer each other for inter-bank deposits. From a bank's perspective, deposits are simply funds that are loaned to them. So in effect, a LIBOR is a rate at which a fellow London bank can borrow money from other banks. Rate calculations are complex as they incorporate variables such as time, maturity and currency rates. There are hundreds of LIBOR rates reported each month in numerous currencies.

Apparently, since LIBOR is a rate that banks charge to lend to each other, it is reflective of confidence in the financial markets. The Eurodollar is a futures derivative that mimics LIBOR. It continues to fall as long as confidence between banks is improving. It is also extremely liquid, with more than 1,000,000 of open interest.

I have begun to wonder, with the Eurodollar approaching a value of 100, if that price is equivalent to a zero percent interest rate for LIBOR. From the CME's website:

"Quoted in IMM Three-Month LIBOR index points or 100 minus the rate on an annual basis over a 360 day year (e.g., a rate of 2.5% shall be quoted as 97.50). 1 basis point = .01 = $25."

This suggests that with the Eurodollar priced today at 99.1300, the LIBOR rate would be .8700%, which is obviously less than 1%. Since the low rate is reflective of high confidence, it appears to represent the return of rising confidence in the financial markets, and particularly the lending between banks outside the United States. It closely mirrors both LIBOR and the Fed Funds rate, but is not set by the Fed.

LIBOR Rising, Unobstructed By Government

This chart shows the Eurodollar futures, which are very liquid, with more than 1 million contracts of open interest. It is linked to LIBOR (London Interbank Offered Rate), which is the rate that U.S. Dollar deposits earn on accounts outside the United States. In an era in which the Federal Reserve artificially manipulates interest rates through quantitative easing, LIBOR and the Eurodollar futures are a more accurate barometer of unobstructed interest rates.

This daily chart shows that Eurodollar futures are gradually, but slowly declining in value because of rising interest rates that investors are demanding to assume the rapidly-expanding risk of investing in dollar-denominated debt, and especially U.S. government debt. With the U.S. treasury planning to borrow about $2 trillion this year, investors are showing increasing skittishness at the idea of accepting this risk without hiking the interest they earn in compensation.

Today's candle indicates a possible breakout is imminent, with "unobstructed" interest rates potentially rising much more rapidly. The long wick on today's candle, however, is somewhat worrisome, since it may form a hammer, a reversal signal. I love to trade the Eurodollar futures because they are very liquid, and move fairly slowly. I consider it to be "easy money".

Leaping LIBOR!

LIBOR and Eurodollar deposits have leaped higher today as interest rates continue to drop even lower! The two futures are closely linked, since Eurodollar deposits are settled at the LIBOR rate. Both represent short-term interest rates on foreign deposits of US Dollars. The Eurodollar is much easier to trade, since it is far more liquid and maintains a very tight, 1-tick bid/ask spread almost around the clock!

Here is a story explaining the lower LIBOR rates.

From Bloomberg:

"Libor, the benchmark for $360 trillion of financial products worldwide, is set by a panel of banks in a survey by the BBA before noon each day in London. The euro interbank offered rate, or Euribor, is published by the European Banking Federation earlier in the day."

Here is another one from Bloomberg that offers a very good explanation of various Interbank rates.

There appears to be a fundamental global conflict between bonds and equities right now. Bond prices seem to be predicting near-depression-era economic results, while equities are signaling a bottom for the stock markets. TED spreads typically have been one of the most reliable indicators of recessions throughout several decades, and they remain quite bearish despite improvements in recent days and weeks.

Other Futures

Here are the charts for three other futures that I have started following. Note the similarity between their charts, as shown here on the daily charts.

Fed Funds

LIBOR

Eurodollar

Dollar Up, Commodities Down

Commodities have taken a big hit overnight as the US Dollar has strengthened. Crude oil, gold, and grains have all moved broadly and significantly lower. Google had blow-out earnings report, followed by Citigroup having a less-awful-than-expected earnings report, and Caterpillar announcing a strong earnings report, that have resulted in the stock index futures moving strongly higher.

This, in turn, has strengthened the US Dollar and created a broad sell-off in Dollar-based commodity prices. LIBOR and short-term interest rates have also risen significantly, continuing the selling of Treasuries in anticipation of the end of the Fed's easing cycle. This is not going to help the housing sector, as interest rates are continuing to rise in recent weeks, after reaching their lows exactly on month ago today!

What a difference a day makes! It was just last Friday that the horrible earnings report of GE caused a sell-off of stocks. Isn't it amazing how connected the financial instruments are around the world? And isn't it amazing how connected they are to the value of the US Dollar?