Credit Markets
The Pressures Continue

The steps by central banks to add liquidity to preserve the workings of the money markets has been only partially successful to date.

At the height of the crisis, the flight to quality meant that the yield on three-month US Treasury bills fell to an intraday low of 2.51%, fully 275bp below Fed Funds.

To put this in context, 3-mth T-bills have traded about 25bp below Fed Funds since June 2006, when the Fed last raised interest rates.

Injections of liquidity into the money markets helped reduce this gap, but it has started to widen once more, suggesting that the crisis is not yet over and the flight to quality continues.

Whether this reflects month-end liquidity influences, or something more sinister, remains to be seen.

Whilst the Fed’s actions to inject liquidity and cut the discount rate have been intended to alleviate the money market, it does not necessarily mean that the Fed will cut rates at the next FOMC meeting.

But it may be too early to discount a concerted cycle of easing, as several conditions have yet to be met.

Moreover, we are only just beginning to see some softening in the labor market and the Fed may need to see much harder evidence of a weakening labor market to embark on a series of interest rate cuts.

But a hint in Mr. Bernanke’s speech at Jackson Hole is that recent economic data may be less useful for the Fed’s forecasts and the central bank is perhaps less inclined to “data watch” and is more conscious of its forecasts of increased downside risks to growth.