The Rising Disconnect between FOMC Policy and LIBOR

The FOMC can loosen interest rate policy, but how much will unsecured interbank lending rates like LIBOR respond?? As it stands right now, the Treasury-Eurodollar spread [TED spread], is at 180 basis points, up from 96 basis points (or so — don’t have access to a Bloomberg Terminal).? 17 basis points of that rise is a rise in LIBOR.? Not the usual response that you expect to loosening monetary policy, but these are unusual times, when credit spreads dominate over monetary policy, even on high quality lending and short term.

It feels like the major global banks don’t trust each other enough to lend to each other short term.? This has impacts on mortgage markets as well, such as the ability to refinance mortgages, and resetting mortgage payment rates even on prime mortgages.

Typically the TED spread does not stay this high for long.? If the FOMC cut the Fed funds rate to 3%, that might normalize things, but for now they will be content with half measures like temporary injections of liquidity.? Now, a 3% Fed funds rate will produce other problems (inflation, lower dollar), and it won’t really solve the overall mortgage credit problems in the short-run, but it is what the market expects by mid-2008.? It might help out in problems with the banks that are on the cusp of creditworthiness, and that is what may drive the FOMC to act.

More later.

3 thoughts on “The Rising Disconnect between FOMC Policy and LIBOR

  1. Nina Easton had a story on CNN Money re an interview with Cheney. In the interview cheney opined that “We do not want to interfere with the basic, fundamental working of the markets”. Well, the markets are not working; they are stuck. So, perhaps it is time to scrap the ideology and find some resolution that includes dear old Uncle Sam. How can the markets become unstuck with the administration openly stating that they will stay on the sidelines and watch the crash.

    First Iraq and now the US.

  2. David,

    Given the whack I took today, after that welcome respite on Friday, can I please have all 150 bps of Fed easing all at once, preferably ASAP? LOL

    Steve

  3. It seems like the combination the weak RMBS/CDO market, mark to market requirements for publicly traded equities, and capitalization requirements for banks is creating a bad positive feedback loop. RMBS goes down, then there are mark to market losses, then capitalization requirements and risk mgmt. force the selling of more RMBS, so RMBS goes down (then shorts pile on)…Not sure where all this ends, but the govt. regs are certainly not helping to create an efficient market for investors in the way they were intended.

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