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Overnight interest rates rise on global recession concerns

Posted Oct 24th 2008 10:35AM by Joseph LazzaroJoseph Lazzaro RSS Feed
Filed under: International markets, Forecasts, Recession, Financial Crisis

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Short-term interest rates rose, but just slightly Friday, on the increased likelihood a global recession will prompt banks to hoard cash, even as policy makers added dollars to the global financial system. The London interbank overnight rate, or LIBOR, rose for the second straight day, climbing 7 basis points to 1.28%.

In addition, the difference between what banks and the U.S. Treasury pay to borrow dollars for three months, the TED spread, rose 4 basis points to 257 basis points Friday. Still, investors / traders should keep in mind the TED spread is still down from 434 basis points a week ago.

Short-term rates, including overnight rates, are key sources of cash for corporations and other large institutions, which use the cash to pay suppliers, make payroll, roll over debt etc. Hence, very high overnight and short-term rates will discourage corporations from conducting business, restricting commerce and slowing the economy, economists say.

Banks hoard dollars, yen in flight-to-safety.

Economist Peter Dawson said Friday concern about a slowdown in GDP among major economies, and a possible global recession, has pushed money out of equity markets -- jolting credit markets.


"This is a clear flight-to-safety, and you can see it all over, particular in the currency market, in a flight to the dollar and yen, and in the bond market. Credit markets have been affected too, but so far rates have not backed-up as much as I thought they would," Dawson said. "Still, central bank officials have to be ready to provide even more dollars to the financial system, to keep credit markets functioning for commerce."

Dawson added that he believed Friday's dollar / yen hoarding was "an overreaction."

"It's not justified from a dollar availability standpoint, because the liquidity is there from central banks, if private banks and institutions need them, so what's occurring now is largely panic hoarding," Dawson said. "At some point, we'll reach an end to the hoarding because it's not based on a scarcity of dollars, it's just irrational fear. But I can't predict when that end will occur."

The LIBOR is particularly important because it determines rates on $360 trillion of financial products worldwide, from home loans to derivatives, Dawson said.

U.S. and European governments have now pledged as much as $3 trillion to unfreeze credit markets, meet demand for dollars, and recapitalize banks.

Monetary Policy / Economic Analysis: As economist Dawson noted, dollars are in demand, due to a flight to safety. Hence, central bank officials have to be ready to use still more tactics and new techniques to keep credit markets liquid for commercial operations.

Tags: banking sector, banks, dollar, interest rates, inthenews, LIBOR, monetary policy, yen

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