For the first time since July, LIBOR rates have started to ease. That’s good news for global investors as recent government guarantees to protect banking systems and inject hundreds of billions of dollars into interbank lending rates begins to show signs of improvement.

This morning, three-month LIBOR sits at 4.42%, down from over 4.81% on Monday morning. The Federal Funds rate, set by the Federal Reserve, is at 1.50%. Typically, in a normalized credit environment LIBOR trades about 50 basis points or 0.5% above the Federal Funds rate. Similar overnight lending rates across Europe and Asia are also declining this week.

LIBOR, or the London Interbank Offered Rate, is a crucial U.S. dollar lending rate tied to over $360 trillion dollars’ worth of financial products worldwide. Critics of the rate, which has remained historically high since last year, blame the British method of calculating the index. A new model was subsequently calculated in New York several months ago by American bankers to determine if London LIBOR rates were accurately reflecting the nervous state of interbank lending markets. The results concluded London LIBOR is indeed accurate.

The TED spread, or the difference between three-month Treasury bills and three-month LIBOR, has also dropped this week to 397 basis points from 464 basis points last Friday. The TED spread hit its highest level since 1984 on October 10.

Though still a glacial decline considering the vast amounts of capital pledged to be injected in global banking systems, the fact that interbank lending rates have begun to normalize is a positive development. The market is starting to price a relaxation of credit stress; this process won’t happen overnight since government guarantees will take time to filter through the broader global economy. Still, this is very good news for nervous investors.

Another beneficiary of government short-term debt guarantees to banks is the investment-grade corporate bond sector.

Investment-grade bonds, dominated by large-cap financial companies, imploded over the last three weeks with indexes for AA, A and BBB credits plunging more than 15%. The sector has never posted such vicious declines in such a short period of time. The Dow Jones Corporate Bond Index now yields 8.69% this morning or a hefty 4.77% above Treasury bonds. In my book, this sector remains the best value for all investors seeking high yield, value and the prospect for capital gains.

But I’m still seeing significant stress across the riskier segment of the yield curve. This tells investors that the broader economy is still weakening as credit lending remains tight, defaults are rising and more companies are headed to bankruptcy.

Junk bonds, emerging market bonds, convertible bonds and other risky credits have continued to decline this week. I’d be more encouraged about LIBOR’s progress this week if this rally was confirmed by tightening credit spreads for high-risk bonds; that’s not happening.
I’m standing by my forecast from last week that global stocks are extremely oversold and poised to rally following weeks of relentless selling. Lower LIBOR rates are a plus.

However, don’t be fooled by new bull market chatter; this remains a secular bear market for stocks as the economy digs deeper into recession over the next six months. Use any rally as another opportunity to sell unwanted stocks and remain highly liquid. Before this is over, the Dow should test or re-test its October 2002 low of 7,286. The economy is far worse today compared to the last recession six years ago. Stay defensive.

Have a nice weekend. See you on Monday.