One measure of the fear in the credit marketplace is the interest rate that banks charge each other compared to the safe overnight rate. This is measured by the LIBOR-OIS spread. LIBOR is the London Interbank Offered Rate that banks charge each other for unsecured funds as quoted in London. The OIS is the Overnight Indexed Swap, the interest derived from the central bank’s overnight rate.
In the U.S., the OIS is based on the fed funds rate. The difference between these two rates offers a useful indicator of the risk perceived in the markets. The Bloomberg chart below shows how the spread was generally a low 10 basis points until the Credit Crisis. After October 2009, the rate returned to those low levels and stayed low in a period we have been calling the “Eye of the Storm.”
As you can see, in recent weeks the LIBOR-OIS spread has turned higher, a clear warning that the new turmoil around the Greek sovereign debt crisis is raising risk levels.
The spread rate is not at a dangerous level yet, but it should be watched closely as its direction is up and may be indicating that a new leg down is just ahead. This will be a topic I’ll delve into more deeply in the next edition of The Casey Report.
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