By Dakin Campbell and John Detrixhe
April 27 (Bloomberg) -- Wherever you look, Federal Reserve Chairman Ben S. Bernanke’s efforts to repair global credit markets are showing signs of working.
The Libor-OIS premium that indicates banks’ reluctance to lend to each other fell to 0.87 percentage point on April 24, the lowest level since before Lehman Brothers Holdings Inc. collapsed in September, according to data compiled by Bloomberg. Companies have raised a record $468 billion in U.S. bond sales this year. Prices of the most senior portions of mortgage bonds backed by prime U.S. jumbo loans have climbed 24 percent in the past five weeks, according to London-based Barclays Capital.
Investor confidence in financial markets is returning after the U.S. government and the Fed agreed to spend, lend or commit $12.8 trillion to end the longest recession since the Great Depression. Finance chiefs from the Group of Seven predicted in Washington on April 24 that the world economy will start to rebound later this year.
“Every place where the Fed has acted aggressively, we’ve seen a meaningful improvement,” said Laurence Meyer, a Fed governor from 1996 to 2002 and now vice chairman of consulting firm Macroeconomic Advisers LLC in St. Louis.
The central bank’s balance sheet expanded by $1.3 trillion to $2.2 trillion since August as the Fed purchased everything from corporate commercial paper to bonds backed by consumer payments on mortgages and car loans. Bernanke also agreed to buy $1.15 trillion of Treasuries and mortgage-backed bonds to keep borrowing rates from rising after cutting the target interest rate for overnight loans between banks to a range of zero to 0.25 percent in December from 5.25 percent in 2007.
TED Spread
Banks are lending to each other again, after credit dried up in August 2007 when losses from subprime mortgages left financial institutions with securities and financial contracts they couldn’t value. They froze when Lehman filed for the biggest bankruptcy in history on Sept. 15. The TED Spread measuring the difference between the London interbank offered rate for three-month dollar loans and the Treasury bill rate rose as high as 4.64 percentage points Oct. 10.
Libor fell for 19 straight days, to 1.07 percent, the lowest since June 2003. That’s the longest streak since it fell 22 days starting Oct. 13, when central banks around the world offered as much dollar funding as required.
“The short-term markets are in much better shape because the U.S. government has done a lot to help,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which holds $90 billion in fixed-income assets.
‘Markets Are Healing’
Libor, calculated by the British Bankers’ Association, helps determine borrowing costs on about $360 trillion of financial agreements ranging from home mortgages to corporate bonds, according to the Bank for International Settlements in Basel, Switzerland.
The difference between Libor and the expected average federal funds rate over the next three months -- the Libor-OIS spread -- surged to 3.64 percentage points the same day as the TED Spread jumped. The gap averaged about 0.11 percentage point from the start of the decade to mid-2007. The spread narrowed to the least since Sept. 12 as Credit Suisse Group AG, Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan Chase & Co. posted first-quarter results this month that beat analysts’ forecasts.
Improvement in Libor-OIS “is an indication that the money markets are healing,” said Thomas Girard, who helps oversee $115 billion in fixed income assets for New York Life Investment Management in New York. “It’s moving in the right direction.”
Consumer Credit
While markets are healing, the Libor-OIS is nowhere near what former Fed Chairman Alan Greenspan would call “normal.” In June, he said that the spread was the best way to tell when lending returned to health, which would be when the gap was about 25 basis points, or 0.25 percentage point.
Consumer credit costs are still high by historical standards compared with what banks pay to borrow, an obstacle Bernanke says must be overcome to fix the economy.
“Restoring the flow of credit to households and businesses is essential if we are to see, as I expect, the gradual resumption of sustainable economic growth,” he said April 3.
The rate on 30-year fixed mortgages averages 1.92 percentage points more than what it costs the U.S. government to borrow for 10 years as measured by yields on Treasury notes. While that’s down from 3.07 percent on Dec. 19, which was the highest level since 1986, according to Bloomberg data, it’s still above the average of 1.75 percentage points in the decade before the credit crisis began.
Bank Stress Tests
Writedowns and losses of the securities total $1.34 trillion, according to data compiled by Bloomberg. More than 60 U.S. financial institutions have failed over the past two years. Financial regulators may force some of the largest U.S. banks to raise capital or conserve cash after accounting for assets held off their balance sheets after releasing results of so-called stress tests on the 19 largest institutions April 24.
Federal Reserve Bank of San Francisco President Janet Yellen signaled this month that the central bank and the government helped create the market distress when they allowed Lehman to collapse, saying the firm was “too big to fail” and its bankruptcy caused a “quantum” jump in the magnitude of the financial crisis.
The U.S. economy is expected to contract. Gross domestic product will shrink 2 percent this quarter, after dropping 5 percent in the first quarter, according to the median forecast of 59 analysts in a Bloomberg News survey.
Prices of some assets may have risen too fast, given the outlook for the economy. Bonds rated CCC returned 24 percent since bottoming on March 9, according to JPMorgan Chase & Co. analysts led by Peter Acciavatti.
‘Very Depressed Levels’
“The appearance of stabilization in some economic data should be viewed in the context that almost all segments of the U.S. economy remain at very depressed levels,” the analysts said in a report dated April 24. “At the end of the day, if the economy stabilizes at a very low level, this is not enough for many highly leveraged companies to see enough improvement in earnings to prevent a restructuring.”
Investors are taking comfort from signs that the U.S. economy is stabilizing after contracting 6.3 percent in the final quarter of 2008. Combined sales of existing and new homes have hovered at an annual pace of 5 million since November and construction of single-family houses was little changed in March for a third month.
Retail sales rose an average 1 percent in the first two months of the year after declining in each of the previous six months. Consumer confidence measures increased from historic lows, and factory surveys, including indexes by the New York and Philadelphia Fed banks, have shown a slower rate of decline in April.
Yield Curve
“The economy right now is in a healing process,” said Jonathan Basile, an economist at Credit Suisse in New York. “We’re stabilizing first. The rebound comes later.”
The Treasury yield curve measuring the difference between two- and 10-year yields is expanding, a signal investors expect growth and inflation to quicken. The gap widened to 2.05 percentage points on April 24, within one basis point of the biggest gap since Nov. 24. The curve averaged below zero in 2006 and the first half of 2007 as investors correctly forecast a recession.
“Time starts to heal things in this business, especially when you have a yield curve that is very steep,” said Donald Galante, chief investment officer and senior vice president of fixed income at MF Global Ltd. in New York, which provides trading execution and clearing services.
Investor Confidence
Investors are gaining confidence in companies, demanding an extra 6.9 percentage points in yield on average to corporate bonds instead of Treasuries, down from 8.96 percentage points in December, according to Merrill Lynch & Co.’s U.S. Corporate and High Yield index. That represents an average annual savings for companies of about $20 million on each $1 billion of bonds sold.
Bond sales by companies with investment-grade credit ratings are 33 percent ahead of the same period in 2007, when they issued the most ever, Bloomberg data show. Securities rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s are considered below investment grade.
“There is a lot of money moving into the corporate bond space,” said Greg Haendel, who helps oversee $6.2 billion as a money manager at Transamerica Investment Management in Los Angeles. “The fixed-income markets will be an indicator on the way back up.”
Yields on top-rated securities backed by auto loans and credit card payments have narrowed as much as 4.35 percentage points relative to benchmark interest rates since hitting record highs in late November, according to JPMorgan data.
Jumbo Mortgages
The average rate on auto loans is 2.67 percentage points above one-month Libor. While that is more than the average of 1.84 percentage points over the past decade, it’s down from about 8 percent in December.
Prices of the most-senior class of “prime-jumbo” mortgage securities climbed about 15 cents on the dollar to about 78 cents in the five-week period ended April 23, according to Barclays Capital.
The average rate on a jumbo mortgage, which is bigger than the types of loans that Fannie Mae or Freddie Mac buy, fell to 6.34 percent last week from 7.65 percent in October, according to Bankrate.com. Non-jumbo rates average 4.80 percent, the lowest level since the 1970s, Freddie Mac data show.
Investors are also buying bonds backed by loans on office buildings, shopping malls and apartment buildings after Treasury Secretary Timothy Geithner announced a plan on March 23 to encourage investors to buy as much as $1 trillion of real-estate assets by using $75 billion to $100 billion from the Treasury and government loans in an effort to cleanse banks of troubled assets.
‘Tough Road Ahead’
The yield spread on AAA debt backed by commercial mortgages has narrowed 3.63 percentage points from about 8.5 percentage points since March 20, Bank of America Corp. data show.
Stocks rallied, Treasuries tumbled and gold fell as credit markets advanced. The MSCI World Index of stocks in developed economies rose 7 percent in the past month after tumbling 25 percent at the start of the year.
Treasuries posted their worst first quarter since 1999, losing 1.2 percent, including reinvested interest, according to Merrill Lynch’s U.S. Treasury Master Index. The gauge is down another 1.5 percent in April. Gold, which reached $1,007.70 an ounce, closed at $913.40 on April 24.
“All these policy actions are removing the downside tail risk and the markets are responding in kind,” said Kenneth Volpert, who oversees $180 billion in taxable bonds for Vanguard Group in Malvern, Pennsylvania. “It doesn’t mean everything is great again. We still have a tough road ahead.”
To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; John Detrixhe in New York at jdetrixhe1@bloomberg.net
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