Credit markets keep improving

Government debt prices are higher, but lending rates continue to fall. Overnight Libor rate hits a record low, as the market is flooded with liquidity.

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By Catherine Clifford, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- Credit markets showed small signs of improvement again Tuesday, with a short-term lending rate falling to its lowest level on record again.

Government debt prices rallied as investors waited to hear the fate of a proposed government bailout of the auto industry and as the stock market lost ground.

The overnight Libor rate fell for the seventh day in a row to 0.14%, according to data available on Bloomberg.com, which pushed the bank-to-bank lending rate to a new record low. Monday the rate was 0.19%, which was the overnight Libor's lowest level on record, according to the British Banker's Association.

The overnight lending rate has been falling to record lows for the past several sessions as central banks have lowered their key lending rates, flooding the system with liquidity.

The 3-month Libor rate also moved lower, falling to 2.16% from 2.19%. The longer term bank-to-bank lending rate has held pretty stable in recent weeks.

Libor, the London Interbank Offered Rate, is a daily average of what 16 different banks charge other banks to lend money in London, and is used to calculate adjustable-rate mortgages. More than $350 trillion in assets are tied to Libor.

Libor rates are watched closely as a gauge of credit market sentiment. When banks charge each other less to lend to each other, that indicates that the level of trust between banks is increasing and that translates into lower lending rates to consumers for auto loans, home loans and student loans.

A record low overnight Libor rate is not shocking when viewed in the context of how many other lending rates are also at very low levels, according to Kim Rupert, fixed income analyst at Action Economics.

Even thought the benchmark lending rate for the U.S. Federal Reserve is at 1%, the effective rate for overnight lending was at 0.12% Tuesday, according to the New York Reserve Bank of New York Web site. Also, the yield on the smaller Treasury bills have been approaching 0% for weeks.

"So the overnight dollar Libor rate is at comparable levels with those," said Rupert. She added that the falling rates are a "function of pretty aggressive central bank easing that we have seen over the past couple of months."

Credit market gauges: The "TED spread" narrowed to 2.13 percentage points from 2.16 percentage points late Monday. 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.

Another indicator, the Libor-OIS spread, widened to 1.91 percentage points from 1.88 percentage points Monday. 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: The price of government debt increased Tuesday, following a slight pullback in government debt prices Monday. The stock market rallied both Friday and again Monday, motivating some investors to move cash out of the safe haven of Treasurys and into riskier assets such as stocks.

But Treasury prices jumped Tuesday as investors waited to find out whether the White House would approve a bill that would get $15 billion to U.S. automakers - a bridge loan that would allow them to avoid filing for bankruptcy in the short term.

"No one can really effectively determine the ramifications or the far reaching effects of a bankruptcy in the auto space," said Kenneth Naehu, managing director and head of fixed income at Bel Air Investment Advisors.

The fate of the U.S. auto bailout is under particular scrutiny in the wake of November's unemployment report from the government which showed the worst month of job losses in 34 years. Employers cut 533,000 jobs in November, which was the largest monthly job-loss total since December 1974, bringing the year's total job losses to 1.9 million.

Government bond prices have been elevated and yields near record lows in the past weeks as unprecedented market volatility has shied investors away from keeping their assets on Wall Street. Government bonds and yields move in opposite directions.

"It is still the case in this environment that people are trying to preserve capital, and about the only relatively guaranteed way to do that is investing in U.S. Treasurys," said Rupert.

Another analyst echoed the sentiment. "It is more of the same. It is the fear premium put into the price of Treasurys," said Naehu. He said that investors would rather earn no profit than lose money on another, riskier investment.

Prices and yields of government debt were in line with the past few weeks of sessions. However, for yields to remain near record lows and prices to remain near record highs - despite a high volume of supply of debt being brought to market - indicates continued heavy demand for the safe haven, said Rupert.

For example, the Treasury auctioned $30 billion worth of 28-day bills Tuesday at a yield of 0%.

The Treasury was also set to auction $20 billion worth of 278-day cash management bills and $28 billion worth of 3-year notes Wednesday. And Thursday, the Treasury planned to auction $16 billion worth of 9-year, 11-month notes.

The benchmark 10-year Treasury rose 31/32 to 109 22/32, and its yield was down to 2.64% from 2.76% late Monday. Two weeks ago, the 10-year yield fell below 3% for the first time since the note was first issued in 1962 and Dec. 4, the yield on the benchmark Treasury closed at a record low of 2.55%.

The 30-year bond surged 2 14/32 to 128 7/32 and its yield fell to 3.04% from 3.15%. The record low yield for the 30-year bond was 3.06%, where the bond closed on Dec. 4.

The 2-year note was up 6/32 to 100 16/32 and its yield fell to 0.85% from 0.96% late Monday. On Dec. 4, the yield on the 2-year note hit a record low of 0.82%.

The yield on the 3-month note was at 0.03%, even with late Monday. The 3-month bill is closely watched as an indicator of investor confidence.

The yield on the 3-month bill was very close to zero throughout the session Tuesday. On Nov. 28, the 3-month yield closed for the day at a record low of 0.01%.

Investors and money-market funds shuffle funds in 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. To top of page

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