Libor Signs

From the dollar Libor to housing, signs are that the financial meltdown is beginning to thaw. The efforts put in by the US Fed in lowering interest rates, followed by quantitative easing, seem to have finally led to the money markets easing off. With the fall of the three month dollar Libor to 0.785%, trust amongst banks seems to increasing. This has substantially reduced the spread between the base rate set by the US Fed and the dollar Libor, which earlier had not eased. The fall from last week’s 0.83% is also now at near lows since mid 1980s. This fall of nearly four basis points also marks the biggest single day decline since March 19, 2009. The three month dollar Libor had shot up to 4.82% post the collapse of Lehman Brothers, indicative of the risk aversion that had set in after the debacle.

The Libor is indicative of cost of capital obtained from global markets and over 50% of US adjustable rate mortgages are linked to the Libor. The fall in the Libor has also been prompted by a surge in consumer deposits, which rose to almost $400 billion in the US in the last six months. This is indicative of a gradual restoration of faith in the banking system as also an increasing propensity to save. The other key reason for improving liquidity appears to be the intention of several US banks to repay emergency funds received via the federal bailout package.

Other signs include a gradual improvement in the stocks and the housing markets. This is apparent from an increase in the Wells Fargo index of builder confidence, which rose to 16 in May. This makes the index highest since September last year. The Reuters/University of Michigan index of home buying conditions also rose to 161 in May from 146 in April. The index is nearly at the 2002-2004 average, which was also the period of the housing boom. The situation seems to be improving other places as well. House prices in the UK have also reportedly firmed up by 2.4% in May compared to April prices. This is the biggest single month rise since February 2008.

All this good news also came with a mixed bag of slowing construction permits in the US, which fell 3.3% in April from a month ago to 494,000. This was lower than record low of 511,000 permits for March. However, it may be a matter of time that new construction activity starts to improve as existing inventory and bad mortgages are still in the market and need to be sold. In any case single family homes experienced a 3.6% rise in building permits.  

Overall, the slight improvement in the housing sector, coupled with a falling Libor is likely to provide the requisite potion for a gradual improvement in the economic sentiment. The general sentiment that the recession is beginning to thaw seems to be reflected in sudden dollar weakness due to waning risk aversion, with the dollar falling against the Euro, the Yen and other key currencies.

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