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.
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.
