Aug. 3 (Bloomberg) -- A gauge of financial-market stress dropped to the lowest level in more than two years amid evidence that financial institutions are emerging from the worst of the global credit seizure.

The TED spread, the difference between what banks and the Treasury pay to borrow for three months, narrowed to 29.4 basis points today, the first time it slid below 30 basis points since March 26, 2007, when it was at 29.2 basis points. The measure has declined 434 basis points since peaking in October last year after the September collapse of Lehman Brothers Holdings Inc.

The Standard & Poor’s 500 Index of stocks extended a five- month rally, topping 1,000 for the first time in nine months, after a report showed U.S. manufacturing shrank in July at the slowest pace since August 2008. HSBC Holdings Plc Chairman Stephen Green said today “the bottom of the cycle” in financial markets may have been reached as the bank posted an unexpected profit. Barclays Plc said first-half earnings rose 10 percent as profit from investment banking almost doubled.

“It’s not anecdotal but related to the fact that volatility has come down, we have higher stock markets and risk appetite is back,” said Alessandro Tentori, a fixed-income strategist at BNP Paribas SA in London. “All this has impacted the TED spread.”

Peaked in October

The spread, the difference between the London interbank offered rate, or Libor, for three-month dollar loans and the yield on the three-month U.S. Treasury bill, peaked at 464 basis points on Oct. 10 last year, a month after Lehman went bankrupt. A basis point is 0.01 percentage point.

Since then, the reluctance of banks to lend to each other has waned as central banks cut interest rates to record lows and offered unlimited funds to financial institutions. U.S. authorities pledged $12.8 trillion in an attempt to revive credit markets and combat the deepest recession in more than five decades.

The credit crunch began in the subprime debt market after BNP Paribas SA halted withdrawals on three hedge funds in August 2007.

HSBC said its net income for the first half was $3.35 billion, compared with a $600 million loss forecast in the median estimate of seven analysts surveyed by Bloomberg News.

“Operating conditions in the financial sector have continued to improve as the effects of government and central bank policies work through the system,” Green said.

Libor-OIS

The Libor-OIS spread, a measure of banks’ reluctance to lend to each other, fell to 28 basis points, the lowest since January 2008. Former Federal Reserve Chairman Alan Greenspan said in June 2008 he would not consider the markets to be back to “normal” before it reaches 25 basis points.

Growth may resume at a faster rate than most economists foresee, Greenspan said today. “We may very well have 2.5 percent in the current quarter,” he said in an interview today on ABC’s “This Week” program.

Libor fell for a seventh day today, to 0.47 percent, the British Bankers’ Association said.

To contact the reporter on this story: Anna Rascouet in London at arascouet@bloomberg.net

Last Updated: August 3, 2009 13:36 EDT