By Liz Capo McCormick and Gavin Finch

Aug. 25 (Bloomberg) -- Most of the bond strategists and salesmen that Resolution Investment Management Ltd.'s Stuart Thomson talked to last August expected the credit crunch to be long over by now. Instead, money markets show there's no end in sight, and it may even worsen.

''It's like an ongoing nightmare and no one is sure when we're going to wake up,'' said Thomson, a money manager in Glasgow at Resolution, which oversees $46 billion in bonds. ''Things are going to get worse before they get better.''

In a replay of the last four months of 2007, interest-rate derivatives imply that banks are becoming more hesitant to lend on speculation credit losses will increase as the global economic slowdown deepens. Binit Patel, an economist in London at Goldman Sachs Group Inc., said in an Aug. 21 report that nations accounting for half of the world's economy face a recession.

The premium banks charge for lending short-term cash may approach the record levels set last year, based on trading in the forward markets, where financial instruments are sold for future delivery. Back then, concern about the health of the banking system led investors to shun all but the safest government debt, sparking the biggest end-of-year rally for Treasuries since 2000.

''These problems going into year-end are likely to be worse this time round because of the amount banks have to refinance in December,'' Thomson said, citing a figure of $88 billion. ''The suspicion is that banks are still hiding losses. The banking system relies on trust and at the minute there quite simply isn't any.''

Rate Spreads

Banks are charging each other a premium of 77 basis points over what traders predict the Federal Reserve's daily effective federal funds rate will average over the next three months to lend cash. The spread is up from about 24 basis points in January, and may widen to 85 basis points, or 0.85 percentage point, by mid-December, prices in the forwards market show.

Former Fed Chairman Alan Greenspan said in June that this spread, which is the difference between the three-month London interbank offered rate for dollars and the overnight indexed swap rate, should serve as a measure for telling when markets have returned to normal.

A narrowing to 25 basis points in the so-called Libor-OIS spread would be viewed as a positive, he said. Forward markets signal that won't happen until sometime after June 2010. The premium averaged 11 basis points, or 0.11 percentage point, in the 10 years prior to August 2007.

Another 2007

Increased turmoil in the money markets may again serve as a catalyst for a surprise year-end rally in Treasuries like the one in 2007.