Credit markets tighten as European debt fears spread

LIBOR on upward trajectory

Stocks in the U.S. turned decidedly lower at the opening but managed to rally through the day to finish almost unchanged, but credit markets continue to slowly tighten as fears grow that the fiscal woes engulfing Greece could spread to other countries and banks in Europe.

The 3-month LIBOR rate rose nearly 3 basis points (bp) to 54 bp today, the highest since July 2009 and more than double the rate seen from early December through mid-March, which preceded the problems that forced the EU to craft a huge bailout of Greece.

LIBOR is the London Interbank Offered Rate which banks can borrow unsecured funds from other banks.  Typically, the rate will hold steady when there are few if any expectations that the Fed is set to adjust interest rates.  The rate can and does drift higher when most analysts and traders expect a rate hike, while forecasts of rate cut will weigh on LIBOR.

Currently, creaks in the financial system have caused a reluctance among those banks with excess funds to lend out to banks their surplus amid concerns that problems down the road could delay or prevent repayment.  Another words, the dwindling supply of cash to lend, without a corresponding dip in demand, is causing rates to rise.

So far, the credit markets have been adapting to the problems overseas, but the rise in LIBOR could put upward pressure on adjustable rates when they reset as well as put upward pressure on consumer loan rates at a time when the recovery is still in its early stages.

But the gradual increase is also a reflection of growing tensions in the global financial system, even with the massive bailout package that was announced earlier in the month. 

The steady but slow rise suggests governments have been able to temporarily address crisis in southern Europe, but major changes in fiscal policy, which may be difficult to implement, are a key part of the solution.