Feb. 17 (Bloomberg) -- The spread between the rate to exchange floating for fixed interest payments and Treasury yields over two years widened to the most in over a month on concern banks may face credit-rating reductions and demand for U.S. government debt as a haven increased.

The difference between the two-year swap rate and the benchmark Treasury note yield, known as the swap spread, widened to as much as 78.25 basis points from 69 basis points on Feb. 13. The spread, now at 72.5 basis points, is a gauge of investor perceptions of credit risk and is based on expectations for the London interbank offered rate, or Libor.

Treasury yields fell the most in a week and global equity markets slumped after Moody’s Investors Service said it might downgrade banks with units in eastern Europe. Swap rates serve as benchmarks for many types of debt often purchased with borrowed money, including mortgage-backed securities and auto-loan securities. This means wider swap spreads can drive borrowing costs higher, even if Treasury yields are steady.

“The movement in swap spreads is a carryover from trading in Europe,” said Fidelio Tata, head of derivatives strategy at RBS Greenwich Capital in Greenwich, Connecticut. “European banks are doing very poorly and since they are part of the U.S. dollar Libor panel this impacts the U.S. swap spread as well.”

Lowest Since Crisis

The two-year swap spread fell to 49.88 on Jan. 12, its lowest since Aug. 2007, before the global credit crisis began. It surged to 167.25 on Oct. 2, the widest since Bloomberg began compiling data in 1988. A basis point is 0.01 percentage point.

Swap rates are traditionally higher than Treasury yields in part because the floating payments are based on interest rates that contain credit risk, such as Libor.

Three-month dollar Libor stayed today at 1.246 percent, its highest level in five weeks, according to the British Bankers’ Association. The overnight rate climbed one basis point to 0.31 percent.

The dollar Libor-OIS spread, a gauge of demand for cash and willingness to lend, widened one basis point to 99 basis points. The spread, which reached a record high of 364 basis points on Oct. 10, averaged about 11 basis points for the 10 years prior to August 2007.

‘Increasingly Concerned’

“I would be increasingly concerned if the two-year swap spread continues to shoot up, toward 80 basis points,” said Michael Darda, chief economist at MKM Partners LP in Greenwich, Connecticut. “Below 60 basis points is normal, so we need to go back in that direction.”

Eastern European banks, which are mainly subsidiaries of financial institutions such as Raiffeisen Zentralbank Oesterreich AG and Swedbank AB, are likely to come under “downward pressure” that may also weaken their parent companies, Moody’s wrote in a report released today in London.

The MSCI World Index decreased 1.55 percent to 818.19 in London, extending its 2009 retreat to 11 percent. The MSCI Asia Pacific Index dropped 2.7 percent and Japan’s Nikkei 225 Stock Average lost 1.4 percent. The Standard & Poor’s 500 Index decreased over 3 percent.

“There is a loss of confidence in the government’s ability to fix the problems” in the economy and credit markets, said Arthur Bass, a managing director of derivatives in New York at the brokerage Newedge USA LLC. “The continued breakdown in stock prices are also causing swap spreads to widen.”

To contact the reporter on this story: Liz Capo McCormick in New York at Emccormick7@bloomberg.net

Last Updated: February 17, 2009 11:14 EST