USA Money Market Rates as an Indicator of Liquidity

Given our long history and experience in fixed income markets, and our belief that bonds lead all other markets, we always keep an eye on the very front end of the bond market, or what is called the money market (bonds and fixed income investments that are less than 1yr to maturity).  We have three indicators we watch that reflect short term liquidity in the US market.

1. 3mos Libor - This is an inter-bank lending rate.  In other words, it is the rate at which one large bank will lend to another for 3mos.  It is a signal of confidence among all banks.  The fact that it is widening tells us that there is arguably some concern about lending to competing banks.  

2. TED Spread - This is the difference between that 3mos Libor and a 3mos US T-Bill rate.  Again, if it widening out, it means that competing banks are putting a premium on lending to each other...not a good thing.

3. US 3mos Commercial Paper - This is the spread vs US 3mos T-bills that US companies can issue commercial paper (CP).  The reason this is so important is that most large companies issue CP as part of the normal course in funding operations and for working capital purposes.  Maybe some people in Canada remember the ABCP debacle?  They were entirely funded with short term CP so when it widens, or worse yet, that issuer loses access to the CP market, then you get an ABCP problem.  We are not saying this might happen but a widening spread is generally not good for the capital markets.    

In general, when investors shun corporate lending (CP,corporate bonds, etc) and require more "spread/yield" in favour of investing in much safer Government bonds, capital markets tend to do poorly.  This is also a form of monetary conditions being tightened by market participants (independent of the Fed which obviously hasn't, and may not need to tighten).  

We seem to be "widening" over the past month or two so this bears watching very closely.