This is a big issue right now. From Barron's:
THE STOCK MARKET STAGED an impressive recovery from steep early losses Tuesday, but was it a case of the symptoms being relieved while the underlying cause of the malady remains?Reports that North Korea had put its military on alert last week supposedly in preparation for a confrontation with the South over the North's alleged sinking of a South Korean only served to upset markets already anxious about the European debt situation.
The latter was encapsulated in a single interest rate, three-month Libor, or the London interbank offered rate. This money market benchmark continued its upward creep, rising another three basis points (.03 percentage points) and a total of seven basis points over the past five trading sessions.
That sounds trivial, but in percentage terms that's significant, given the rise brought Libor to 0.53625%. That's roughly double Libor's level early in the year and the highest since early 2009, when the worst of the credit crisis was fading. Remember that the federal funds target set by the Federal Reserve has remained unchanged throughout at 0-0.25%.
The widening in the spread between the Fed-set overnight funds rate and three-month Libor, which is set by a survey of major international banks by the British Bankers Association at late morning in London, reflects the higher rates that some European banks are having to pay. The money market is demanding a premium from banks, especially those that own lots of bonds from the weak-credit governments of Greece, Portugal, Spain, Ireland and Italy.
Here's why this is an issue. Consider this chart of the a2/p2 spread from the US
Notice the huge jump in the short-term rates in the US at the height of the financial crisis. While Libor is nowhere near those levels, a sharp increase in short-term rates is indicative of problems in the financial market. That's what the real issue is here.
