An obscure interest-rate spread watched closely by former Federal Reserve Chairman Alan Greenspan signals continued financial turmoil ahead.
The Libor-OIS spread shows that banks see no end to the crisis before next year, Bloomberg notes. That spread measures the premium banks demand for lending short-term to other banks.
“Libor-OIS remains a barometer of fears of bank insolvency,” Greenspan recently told Bloomberg.
“That fear has been substantially reduced since mid-October, but the decline has stalled well short of any semblance of normal markets.”
The spread represents the difference between the London interbank offered rate for three-month dollar loans and the overnight index-swap rate. The swap rate is what traders expect the target federal funds rate to average over the term of the contract.
The spread broke above 1 percentage point last week for the first time since Jan. 9, showing the bank were afraid of making loans.
Greenspan said in June he won’t consider markets back to “normal” until the Libor-OIS falls to 0.25 percentage points.
But market activity shows traders anticipate the spread will narrow only to 0.87 percentage point by December, according to Tullett Prebon brokerage.
Greenspan isn’t alone in worrying that the financial crisis won’t end soon.
“We are still in the third and fourth innings,” economist Nouriel Roubini told Reuters.
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