Update on stress indicators – VIX and Libor improving

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This post is a guest contribution by Asha Bangalore vice president and economist of The Northern Trust  Company.

The Greece, Portugal and Spain crisis/EU crisis unsettled financial markets and led to immediate favorable and unfavorable developments. On the unfavorable side, the immediate and visible effect was a sharp increase in the Market Volatility Index which shot up to 45.79 on May 20 to the highest level since March 2009 (see chart 1). As of May 27, the index closed at 29.68 [PduP; 32.07 on Friday]. The nearly trillion dollar package of the EU and IMF brought gradual relief to equity markets.

Another unfavorable impact has been the nearly 25bps increase of the 3-month Libor rates in a very short period of about two months (see chart 2). All Libor-related dealings are affected by this increase in cost of short-term funds. It represents a constraint in markets when setbacks in financing costs are least desirable. The good news is that today’s 3-month Libor quote (0.5363%) is off from the recent high posted on May 27 (0.5384%).

The foreign exchange rate of the dollar and Treasury market yields are the much followed market data which show a noticeable change as the EU crisis has unfolded. The greenback has appreciated almost 16% year-to-date vis-à-vis the euro, with the appreciation since mid-March at around 11%. The dollar has risen nearly 7.0% on a trade weighted basis in the first five months of the year. Oil prices have fallen as a result of the strengthening of the dollar. The net impact of a stronger dollar is expected to mildly negative on U.S. economic growth via the trade deficit because the contribution from exports to the EU has been (in recent months) and will be significantly smaller than exports to Asia and Latin America.

The unexpected gain from the Euro-zone crisis and the ensuing flight to safety was a rally in the U.S. Treasury market. As a result of a lower 10-year Treasury note yield, mortgage rates have dropped to historical lows (see chart 4). The 30-year fixed rate on mortgages was last quoted at 4.78%, down nearly 40 basis points since April 7, 2010.

Source: Asha Bangalore, Northern Trust Daily – Global Commentary, May 28, 2010.

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