The cost to borrow in euros through the end of the year...

The cost to borrow in euros through the end of the year plunged after the European Central Bank added an unprecedented $500 billion to the banking system as part of a global effort to ease credit-market gridlock. BEA 4th Quarter GDP 1st Estimate 0.7% Q&A: Why Did GDPNow Rise After Durable Goods? When are Construction Revisions Coming? The amount banks charge each other for two-week loans in euros dropped a record 50 basis points to 4.45 percent, the European Banking Federation said today. The rate had soared 83 basis points in the past two weeks as banks anticipated a squeeze on credit through year-end. 'These are strong-arm tactics intended to show the market they're seriously committed to breaking the deadlock,' said Marc Ostwald, a fixed-income strategist at Insinger De Beaufort SA in London. 'The ECB is helping to bankroll banks out of a problem that they themselves created.' The Bank of England held the first of two special operations today, offering 10 billion pounds ($20 billion) of three-month cash. The cost of borrowing pounds for three months dropped 4 basis points to 6.39 percent, the fourth straight decline. That's still 89 basis points higher than the central bank's benchmark interest rate. '$500 billion is an enormous amount of money. To put it into perspective, $500 bln is 5% of total US banking system assets. My eyes are on LIBOR. If $500 bln doesn't move the rate... Furthermore, everyone should remember that the $500 bln is funding just through year end. Come January this will need to be refinanced or rolled over.' So while there was a whopping reaction in Europe, there was a big yawn in the US and UK. Curve watchers anonymous offers this chart to consider. A casual look shows LIBOR to be 40 basis points lower than it was a year ago. But that is not what everyone should be watching. The important factor is where LIBOR is in relation to the Fed Funds Rate. In this case it is a whopping 70 basis points higher than it was a year ago. A normal spread would be closer to 10 basis points. LIBOR was sitting at 5.25 right before the last rate cut by the Fed so it merely dropped with the cut plus another 5 basis points. It has not budged today. Impact of the ECB's move on the US yield curve was negligible. The short end of the curve actually rose a couple of basis points. Banks in the US are continuing to hoard cash. Who can blame them? The Bloomberg article above offers a possible explanation: 'U. S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003, according to Moody's Investors Service.' The key word in all for point above is 'yet'. News about housing, subprime lending, SIVs, and other related stories are what dominate the headlines now. However, second, third, and fourth waves of the economic tsunami are coming. Right now, most of those stories have not hit the front page yet, certainly not day after day. They will. If this $500 billion 'emergency funding' was just a year-end phenomenon, that would be one thing. But this is not a liquidity issue this a solvency issue and a growing solvency issue as well. See You can't cure drug addicts by giving them more drugs nor can you cure insolvent credit junkies by dramatically increasing the size of the loans. I suspect the 'emergency' is going to last a lot longer than the ECB thinks. The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.