Credit choked on recession angst

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NEW YORK (CNNMoney.com) -- Anxiety about a worldwide recession made credit even tighter Friday, as banks and companies opted to hang on to their cash rather than risk lending money out.

With confidence waning, investors poured funds into U.S. Treasurys, hoping to find a safe place for their money.

At one point Friday, the yield on the 30-year bond sank to its lowest level in its 31-year trading history, to as low as 3.87%. Other government bonds also rose, sending the 3-month bill's yield below 1%.

"People are becoming worried about the economic costs of the credit crisis," said Steve Van Order, chief fixed income strategist at Calvert Funds. "Fears are spreading around the globe."

For the past two weeks, central banks around the globe have attempted to stimulate confidence in investors and financial institutions by encouraging lending. They have taken measures to lower interest rates and directly inject capital into the banking system.

However, signs that economies around the world are sinking into a deep, prolonged recession have renewed worries. The British economy appeared to be on the brink of recession Friday, as economic output in the United Kingdom declined for the first time sine 1992.

Lending: Short-term lending rates rose for the second straight day. The overnight Libor rate edged up to 1.28% from 1.21% the day before, according to Bloomberg.com. Libor is a daily average of what 16 different banks charge other banks to lend money in London.

The overnight bank lending rate had been steadily declining for nearly two weeks from nearly 7% after the signing of the bailout package. Despite its recent rise, it still remains below the rate that federal banks charge other banks - which is generally viewed as an encouraging sign for the credit markets. The federal funds rate stands at 1.5%.

But with central banks taking such an active role in stemming the credit crisis, rates will likely continue their drop.

"Rates will continue to come down, because the central banks' tools will work," said Van Order. "But the central banks have taken over so much control, that it will require them to stay heavily involved for the long haul in order to achieve overall stability."

Longer-term rates actually fell very slightly, yet lending still remained tight. The 3-month Libor fell to 3.52% from 3.54% on Thursday, according to Bloomberg. The 3-month rate has fallen steadily for two weeks since it surged to just below 5% on Oct. 10 - a 10-month high. The rate was under 3% before the recent credit crisis took hold in mid-September.

Market gauges: Two key indicators of risk sentiment showed confidence in the market was falling.

The "TED spread" rose to 2.64 percentage points from 2.53 points Thursday. The TED spread measures the difference between the 3-month Libor and the 3-month Treasury bill, and is a key indicator of risk.

The higher the spread, the more unwilling investors are to take risks. The spread was 1.21 percentage points before the credit crisis and reached a record high of 4.65 points a little more than a week ago.

Another indicator, the Libor-OIS spread, edged higher to 2.61 percentage points from 2.51 points Thursday.

The Libor-OIS spread measures how much cash is available for lending between banks, and is used for determining lending rates. The bigger the spread, the less cash is available for lending.

Treasurys soar: Government debt prices were mostly higher Thursday, as global stocks plummeted. Investors tend to flock to Treasurys in times of economic uncertainty because the safety of lower returns offsets the risks of more lucrative equities.

The benchmark 10-year note rose 2/32 to 102-21/32, and its yield fell to 3.68%. Bond prices and yields move in opposite directions.

The 30-year bond gave up earlier gains to end the day nearly flat from the previous day, at 107-22/32, with a yield of 4.05%. Earlier in the day, prices rallied with the yield dipping below 3.90% for the first time since the 30-year began trading in 1977.

The 2-year note rose 7/32 to 100-31/32, and its yield fell to 1.50% from 1.59% late Thursday.

The yield on the 3-month bill fell to 0.88%, down from 0.94% on Thursday.

The yield on the 3-month Treasury bill is closely watched as an immediate reading on investor confidence. Investors and money-market funds shuffle funds into and out of the 3-month bill frequently, as they assess risk in the rest of the marketplace. A higher yield indicates that investors are slightly more optimistic.

But with so much government action to boost the markets, bonds may not rise much beyond their current levels.

"With all the liquidity injections and moves to prop up the money markets, we're not going to see yields fall much further," said Van Order. "If you believe the Fed is going to cut rates to 0%, then we could see yields really come down and the 3-month bill around 0%."