October 20, 2008

Market Data & Commentary

By Bruce Six, Senior Vice President - ALM

When will the credit markets thaw? That is the question everyone wants answered and unfortunately it won’t be clear when the markets have returned to normal until after the fact. We do see some indicators that credit is beginning to flow with the falling LIBOR (London Inter-Bank Offered Rate) which represents the rate that European banks are lending US dollars to each other. Unlike the Federal Funds rate, LIBOR is “fixed” daily by surveying a small group of banks in Europe. While this rate is typically close to the fed funds rate, for months now the LIBOR rate has been significantly higher, indicating European banks have been reluctant to lend to each other because of the fear the money could be lost if the borrowing bank fails. The 3-month LIBOR rate has fallen in recent weeks from very very high rates to merely very high rates as banks gain confidence that the money they lend to other banks will be paid back. The LIBOR rate does not have a direct impact on US based credit unions but it does impact any investment made that is indexed to LIBOR (usually the 1-month or 3-month LIBOR rate) and adjustable rate mortgages indexed to LIBOR. For our purposes we can look to the LIBOR rate and its relationship to the Fed Funds rate as one indicator of how chilly the credit markets are.

As we look to the general health of the economy it has become very evident that the economy is not going to be displaying robust growth any time soon. The slowing economy has relieved the pressure of inflation and has shifted very quickly the concern of inflation to a concern of deflation. This has allowed the forecast for future interest rate moves by the Fed to similarly shift from rising rates to falling rates. The “Future Market Rate Expectations” chart below clearly shows that the next move by the FOMC is now expected to be down as much as 50 basis points to 1.00% for the Fed Funds Target rate. The chart indicates down 50 as the next forecasted move because that is a slight majority of the expectations with down 25 being a very close second. Two thoughts could take place with the next rate move. If the Fed lowers the full 50 basis points it could be looked at as yet another aggressive attempt to unlock credit and push on the gas pedal of the economy. Or, the Fed could move just 25 basis points and essentially keep some additional easing in reserve if needed. The markets have been treating a 1.00% Fed Funds Target as a floor but if the economy is setting up for a protracted recession, the Fed can push rates below 1.00%.

When looking at your balance sheet and thinking forward into 2009. Be careful when setting loan rates aggressively low. Many of our traditional competitors including GMAC and Ford Motor Credit and credit card issuers like Capital One are retreating from the market so credit unions should be able to compete for loans on a battlefield with fewer combatants. The rates we charge for loans are compensation for the risk the loans represent to the credit union and it is not a bad thing for the credit union to get compensated for taking on that risk.