One of Alan Greenspan’s favorite credit-market indicators now shows that the financial system will return to normal by mid-2011.
The gauge trumpeted by the former Federal Reserve Chairman is the Libor-OIS spread. It measures the premium of Libor (the London interbank offered rate) over the OIS (overnight indexed swap) rate.
On Wednesday, the spread narrowed to 32 basis points, its lowest level in more than 17 months, Bloomberg reported.
Forward contracts imply that the spread will drop even further, to 25 basis points by June 2011, according to data compiled by Tullett Prebon.
That 25-basis-point level would indicate that credit markets have returned to normal, Greenspan said a year ago.
“Greenspan’s right,” David Keeble, head of fixed-income strategy at Calyon in London, told Bloomberg. “If you get down to 25 basis points, you can say that’s a normal level. However, normality also depends on the activity in the interbank market as well as the level, which has been rather artificially induced.”
The Libor-OIS spread averaged 11 basis points in the five years prior to August 2007, when the financial crisis began. It peaked at 364 basis points Oct. 10, 2008.
While credit markets may be calming, investors still are worried.
"The start to the third quarter marks a sharp turn in investor sentiment from the risk tolerance of last quarter, as economic fears were re-ignited,” Bank of America strategist Jeff Rosenberg wrote in a note to clients, cited by Dow Jones.
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