Credit Spreads

Libor-OIS Spread

The LIBOR-OIS spread is used by economists and financial analysts as a measure of the availability of cash among banks.  The higher the spread, the fewer available dollars. The London Inter-Bank Offered Rate (LIBOR) is the interest rate that banks charge each other for three-month loans in U.S. dollars.  The rate is set by a panel of banks in a survey by the British Bankers’ Association each day around noon in London.  LIBOR is also used as a benchmark for approximately $360 trillion of financial products across the globe.  The overnight indexed swap (OIS) rate is an interest rate swap transaction in which the overnight rate is exchanged for a certain fixed rate.

The spread has improved dramatically from the height of the credit crisis.  However, with the turmoil in Europe over sovereign debt, the spread spiked up again in the summer of 2010.  It appears, though, that since the onset of the worries, moves by the European Union have restored confidence in markets, as observed by the LIBOR-OIS spread returning to more normal levels.  The U.S. Federal Reserve’s second quantitative easing program also helped to keep rates low.  How interest rates respond to the end of the program on June 30, 2011, the ongoing sovereign debt issues in Europe, and the U.S. debt debate will directly impact investment decisions.

TED Spread

The TED spread, which is the difference between what the government and companies pay for three-month loans.  It recently dropped below its historical average since hitting a record high of 464  basis points (4.64 percent) on Oct. 10, 2008.  The gap averaged 27 basis points (0.27 percent) from 2002 through 2006, before the credit crisis began in 2007.  Since hitting lows in March, the TED spread spiked upward due to the turmoil in Europe.  Like the LIBOR-OIS spread, the TED spread returned to low levels, most likely due to the Federal Reserve’s purchase of $600 billion of Treasury securities during its second quantitative easing program. The spread has been heading higher lately, reflecting the uneasiness of many investors.

Key Interest Rates

LIBOR

To view current and historical LIBOR rates, please see the British Bankers’ Association website by clicking on the following link: http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=141&a=627.