Welcome back MM readers--apologies for the unscheduled hiatus last week. I spent a few days enjoying the technological miracles of the US healthcare system. Keen readers may notice I almost never make a call on stocks, stock sectors, or egads….single name stocks--but it is tough for a trader to walk away from a couple of days in and around a hospital without thinking that there is a lot of capital and profit sloshing around in that place. Since I was disconnected from markets much of last week I’m going to circle back to the widening in LIBOR/OIS spreads that has continued unabated since I wrote about it a few weeks ago. I'm sure this has been to the erm...consternation of more than a few traders like our good friend here: Actual footage of a macro trader reacting to the latest LIBOR fixingsJPM published this chart showing that the current 3mo libor/ois spread is at its widest post-crisis level. That’s amazing, given nobody has really noticed outside of this small sector of the fixed income market. Even the 2016 money market reform move made some headlines in the financial media, even if it didn’t penetrate the white hot din of the US election media coverage. Sure, there have been a few articles in bloomberg and the WSJ that have highlighted the move higher in LIBOR, what might be driving it and what it might mean for the regular Joe. Quite honestly, with a little time away from it, I think the coverage has overcomplicated the issue. What I think the market is missing is that this really is a plain vanilla credit story. What makes it different is the magnitude of the move, one driven by the confluence of competing supply and demand factors. Yes, there are many factors that are driving this move, but I think they can be simplified into only two or three. The first, and arguably most important, is the US tax reform. This incentivized US corporate treasurers to start repatriating foreign-domiciled assets, much of which was invested in short-term corporate debt. And yeah, that matters! What I think has been slightly deceptive in the media coverage of this move is that it has been sold as “having nothing to do with credit,” or that credit hasn't been a driver because various other basis trades (3s6s, xccy basis, etc.) aren't moving much. That’s only partially true, especially when you look at this chart: Put another way, since the beginning of February you’ve lost all of the spread tightening move since June of last year. This chart also highlights that the weakening of markets in general might also be at play here--an overall weakening of credit markets has caused a re-pricing of the entire credit complex...including commercial paper, bank funding and thus LIBOR. The second factor is commercial paper. Treasurers are pretty smart people--and most of them have a guy that is sitting in front of a bloomberg terminal all day thinking about how he can fund the company’s working capital 5bps cheaper for a few months. When these guys figured out the tax reform was for real and, later--that there would be an acceleration in t-bill supply because of the bipartisan spending agreement struck in early January, those treasurers wasted no time in tapping the market. Commercial paper outstanding accelerated throughout Q4 and picked up at an even faster pace in January. This acted as a sponge for money market cash......Which left the market dry as a bone when the US government dramatically accelerated t-bill issuance in February, increasing the amount of bills outstanding from roughly $2trn to $2.2trn. You can see how these trends impacted the market by looking at this chart:LIBOR and commercial paper rates underperformed OIS starting in December, but flattened out in January. Similarly, 3m t-bill rates and OIS followed each other very closely until the t-bill issuance accelerated sharply in February. At that point all bets were off--with CP rates and t-bill rates widening amid weakening credit markets and an decrease in dollar funding supply, LIBOR started to underperform everything, since panel banks saw that issuance concessions were back and weaker panelists probably had to pay up to get deals done. The rest, as they say, is history. Where does the market stand now? Pretty nervous, to say the least. 3mo/3mo forward (June fra/ois) blew out to new wides last week, and the 6m3m (Sept fra/ois) is again skulking around the 40 level. This seems like the capitulation move here--L/OIS over 50….money market investors are going to look at that and say this is where we can step in, and there is already some evidence this is happening. I continue to believe that the market will stabilize in the low-mid 30s and we’ll see a return of a more normal looking upward sloping term structure. But when? That’s the big question I guess--however you look to structure this trade, it will be worth considering how much carry and resilience it built into the trade.
Pub chain blames manufacturers for passing down sugar tax, forcing it to charge customers more JD Wetherspoon has increased the price of sugary soft drinks such as Pepsi by 10p ahead of the new sugar tax which the pub firm said would cost it £3m this year.The chairman of JD Wetherspoon, Tim Martin, said drinks manufacturers were passing on the cost of the sugar tax, which comes into effect next month. Continue reading...
"Where Will It Stop?": Libor Spread Blows Out Beyond Eurocrisis Highs, Central Banks Intervention Awaited
Until two days ago, the critical level for both the Libor-OIS and FRA-OIS spread was the "psychological level" of 50bps. This, however, was breached on Wednesday when as we reported Libor pushed significantly higher without a matching move in swaps. And yet, despite the sharp push wider, both spreads remained below the peak levels observed during the European sovereign debt crisis of 2011/2012, with some speculating that open central bank swap lines at OIS+50bps would limit the move wider. That changed this morning when the day's 3M USD Libor fixing jumped higher for the 27th consecutive session, rising to 2.2018% from 2.1775%, and the highest since December 2008. And, as has been the case for the past two months, the move was again not matched by OIS, resulting in the Libor-OIS spread jumping to 51.4bp, surpassing the 2011/2012 highs and the widest level since May 2009. At the same time, the FRA-OIS also spread spiked to a new multi-year high of 53.3bps, the highest in years. Commenting on the move, NatWest Markets strategist Blake Gwinn urgent clients "don't fade FRA/OIS’ recommendation is still in effect, but certainly on watch", adding that the most frequently asked question this week has been "where will Libor stop?" While the clear answer - at least for now - is "not here", Gwinn repeated what we said on March 14, noting that the Fed’s central bank swap lines should "theoretically put a cap on USD funding rates" as the banks are authorized to offer terms out to three months at OIS+50bp, and also echoed BofA's comments on the topic, noting that among the impediments are haircuts that add roughly another 10bp to the effective rate, the stigma of going to central banks for funding, and lack of availability of swap lines. And yet, should Libor keep pushing wider, the Fed will have to notice. As we said two days ago, the Federal Reserve is increasingly monitoring the rise in LIBOR and is trying to understand what exactly is driving it. In fact, in the most recent dealer survey the Fed specifically asked about the 3m L-OIS spread widening. As a quick reminder, we previously laid out the 6 possible reasons for the ongoing spread blow out: while this is a simplification of the various catalysts behind the spike in Libor-OIS, here is a quick summary of what is going on - the expansion of Libor-OIS and basis swaps have been impacted by a complex array of factors, which include: an increase in short-term bond (T-bill) issuance rising outflow pressures on dollar deposits in the US owing to rising short-term rates repatriation to cope with US Tax Cuts and Jobs Act (TCJA) and new trade policies, and concerns on dollar liquidity outside the US risk premium for uncertainty of US monetary policy recently elevated credit spreads (CDS) of banks demand for funds in preparation for market stress Those who say "don't panic" have been focusing entirely on the first three, while traders are increasingly concerned that the answer may be found in the latter, and far more concerning, three explanations. To be sure, the wider the spread blows out, the more likely it is that something far less benign is causing the move than merely the surge in T-Bill issuance (which the market is well aware will subside soon, and can price it in), or simple supply/demand mechanics for CP/CD. In fact, should Libor keep rising and LIBOR-OIS blowing out, it won't matter what is causing it as banks will suddenly find themselves in a severe funding shortage, because just like the VIX-market "tail wags dog" relationship - which took the market about 3 years to figure out despite repeated warnings by this site - so the tighter financial conditions become, the wider the spread will move in a similarly reflexive move. Unless the Fed intervenes of course... which with Libor blowing out so aggressively, is precisely what traders are wondering may happen. The Fed is certainly aware that the around 35bp increase in 3m LIBOR-OIS since mid-November equates to roughly 1.4 hikes. However, according to BofA, the Fed is probably monitoring LIBOR in the context of broader financial conditions and is not yet sufficiently concerned by the recent tightening to adjust policy. Indeed, the Chicago Fed financial conditions index has tightened, but still shows conditions are much easier vs when the Fed started tightening policy in 2015. In other words, while the Fed is aware of the blowing out Libor spread, it is unlikely to intervene - i.e. cut rates - unless stocks finally notice and tumble as a result of the sharply tighter monetary conditions on the front end. * * * What about the Fed's existing swap lines at OIS+50bps: will they provide a ceiling? According to a recent research report by Citi, the answer is no. As Citi rates analyst Ruslan Bikbov writes, "we have received a number of questions on whether central banks currency swap lines may be tapped and form an effective ceiling for LIBOR/OIS at 50bp." First, some background: in October 2013 the Fed converted temporary liquidity lines to standing arrangements with the following five central banks: BOC, BOE, ECB, SNB, and BOJ. A dollar FX swap between the Fed and a foreign central bank involves two transactions. At the start of the swap, the foreign central bank sells local currency to the Fed in exchange for USD at the market exchange rate. The dollar amount is held at the foreign central bank’s account at NY Fed, while the foreign currency is held at the Fed’s account at the foreign central bank. The foreign central bank is bound to buy the local currency back at the same exchange rate and to pay interest to the Fed at the termination of the swap. Since December 2011 - the peak of the European sovereign debt crisis - the required interest was reduced from OIS+100bp to OIS+50bp. There is no limit on the size of swaps. Foreign central banks offer swapped USD to corresponding domestic banks at pre-announced fixed rate tenders with full allotment, most often with the term of 7 days. These loans are secured by accepted collateral denominated in local currencies. As such, the OIS+50bp funding offered by swap lines suggests LIBOR/OIS may see a ceiling at 50bp. The fact that 3m LIBOR/OIS didn’t go above 50bp in late 2011-earlier 2012 may support this idea. However, according to Citi, this simplistic argument misses the following considerations: The term of the loan. The terms of the loans are ECB/BoJ’s discretion. As discussed, a typical term of the loan is 7 days. While central banks offered longer-term (3-month) before, this was done during crisis times, such as in 2011, when solvency of the banking system was in question. ECB and BoJ also provided longer funding (2-3 weeks) over year-ends to reduce dollar funding pressures of their banks. Given ECB/BoJ’s inaction during the US MMF reform, we do not expect them to extend their tenor beyond 1-week. Even if they decide to act, we still expect OIS+50bp to work as a “soft” ceiling than the “hard” ceiling, given the factors discussed below. Stigma. Reaching to FX swap lines may be associated with non-trivial reputation risks. We hear anecdotal reports of foreign central banks dissuading their banks to use the facility as it may signal systemic risks Collateral. While Libor represents the cost of an uncollateralized CP/CD funding, FX swap lines are secured by accepted collateral denominated in local currencies with rather restrictive haircuts. For example, the BOJ requires a 13% haircut for yen-denominated collateral, while the ECB requires a 12% haircut in addition to any usual haircuts applied to ECB loans. Furthermore, the fact that both FRA and L-OIS are now above 50bps confirms that these lines are indeed not being used (unless they are, in which case we will get a confirmation when the Fed and other central banks report their weekly usage on swap lines next). But don't hold your breath: the restrictive collateral and stigma explain why the usage of dollar swap lines remains minimal despite the fact that 3m FX OIS for EUR, JPY and CHF already are trading at levels below -50bp for 3M. Meanwhile, over the last few years, even 1w FX OIS has been exceeding -50bp at month ends, implying only a “soft” ceiling, despite the availability of weekly liquidity offerings. Here Citi notes that FX OIS were trading at much wider levels back in 2016, yet the usage of FX swap lines also remained minimal at that time. Citi's conclusion: "do not expect much usage of FX swap lines in this environment either, although we will be watching out for ECB/BoJ’s longer-dated swap lines." Which brings us back to the underlying crisis. As we discussed first last October, the main reason for the recent widening of FRA/OIS is uncertainty about corporate cash holdings following deemed reparation of offshore cash. As a result of this uncertainty, the demand for CP/CDs with maturities longer than 1m-3m from offshore funds and corporate Treasuries has evaporated, which is evident from the contraction of average maturity of outstanding CPs. As such, FRA/OIS levels may continue to blow out until this persistent uncertainty is resolved, which is unlikely to happen before corporate earnings announcements in Q2. The problem is what happens should Libor (and associated spreads) blow out so much in the next month until Q1 earnings season begins, that corporations and banks finally throw in the towel as a result of the collapse in funding, and demand a central bank bailout, one which will only be greenlit in the old-fashioned way: with a market crash.
Chris Hughton spent £40m on eight players in the summer – for a promoted team to build a competitive top-flight squad for that money looks almost like witchcraftIt takes Neymar just under six weeks to earn £3m. This season the Chinese side Meixian Techand reportedly gave their players a £3m bonus each, just for winning promotion. The payoff that Claudio Ranieri received after being sacked by Leicester was also £3m.These days £3m does not get you much. Unless you are Brighton that is. For their £3m they got Pascal Gross, the player who has registered the most assists of anyone playing for a club outside the top six this season. Continue reading...
More than 100 protesters were arrested at the heavily-policed DSEI, which took place in September 2017 in London.
Over the weekend, when we noted the ongoing blow out in the Libor-OIS spread, we asked whether a dollar funding crisis is emerging , now that this traditional indicator of monetary tightness and systemic credit stress has blown out to levels last seen during the European sovereign debt crisis of 2011. One day later, Bank of America's rates strategist Mark Cabana used the same chart as his "chart of the day", noting that "the 3-month USD LIBOR-OIS spread recently widened sharply to levels not seen since the European peripheral crisis in 2011-12." Noting that while it is hardly indicative of "heightened bank credit concerns, but rather reflects a number of factors that have worsened the supply-demand backdrop and impacted the price of funding", BofA then said it expects the widening in 3m LIBOR-OIS will likely get modestly worse before it gets better due to structural shifts in money markets. We are not expecting a quick retracement due to (1) a possible acceleration in offshore corporate cash repatriation, (2) uncertainty over how quickly a new marginal buyer will emerge or issuer diversification will occur and (3) ongoing reserve draining. We expect higher overall front-end borrowing rates to persist for some time, but do not expect this tightening in conditions to materially impact the Fed's gradual rate hiking path. According to Bank of America, the recent 3m L-OIS spread widening to four factors, in order of priority: Elevated front-end supply: Following the Congressional agreement to suspend the debt limit on 8 February the US Treasury has issued a whopping net $283bn of Treasury bill supply inclusive of the settlements this week (Chart 2). For context, the amount of supply over the past five weeks has exceeded the net bill supply in 2017 by over two times. The elevated front-end supply has caused Treasury bills to cheapen notably vs OIS (Chart 3). This has supported a cheapening of other money market products and forced banks to raise their borrowing rates to attract funding, especially since financial CP outstanding recently hit the highest since MMF reform (Chart 4). Repatriation: As discussed here, many corporates are likely in the process of building liquidity ahead of a draw down in large cash pools overseas. One way to evidence this activity is through offshore USD MMF. AUM in offshore prime USD MMF increased from $240bn to $320bn after the 2016 election likely as expectations for repatriation built (Chart 5). As the tax law moved to completion late last year offshore USD MMF fund managers became defensive anticipating future corporate outflows (Chart 6). Defensive positioning: Onshore institutional prime MMF WAMs have recently declined reflecting defensive posturing amid elevated front-end supply and in anticipation of the March FOMC rate rise (Chart 7). Reserve draining: The Fed's balance sheet unwind and recent build in the Treasury's cash balance will serve to drain excess reserves and tighten funding. Meanwhile, going back to our most recent post on the Libor-OIS spread, we noted that while the overall move wider was expected, the speed of the blow out has taken most analysts by surprise, and the result has been a scramble to explain not only the reasons behind the move, but its sharp severity. Abd while this is a simplification of the various catalysts behind the spike in Libor-OIS, here is a quick summary of what is going on - the expansion of Libor-OIS and basis swaps have been impacted by a complex array of factors, which include: an increase in short-term bond (T-bill) issuance rising outflow pressures on dollar deposits in the US owing to rising short-term rates repatriation to cope with US Tax Cuts and Jobs Act (TCJA) and new trade policies, and concerns on dollar liquidity outside the US risk premium for uncertainty of US monetary policy recently elevated credit spreads (CDS) of banks demand for funds in preparation for market stress To be sure, in recent posts... Why US Tax Reform Will Put Even More Pressure On Dollar Funding Markets Libor-OIS Blowing Out On Rising Repatriation Concerns, Collapsing Front-End Funding Libor-OIS Contagion: As Spread Blows Out, It Starts To "Infect" Other Markets Libor-OIS Blows Out As Libor Rises Above 2% For The First Time In 10 Years ... we have taken a detailed look at each of these components, of which 1 thru 3 are the most widely accepted, while bullets at 4 through 6 are within the realm of increasingly troubling speculation, and suggest that not all is well with the market, in fact quite the contrary, and would imply that contrary to what BofA and various other commentators have suggested, bank credit concerns are indeed becoming a relevant issue. Still, as we explained on Sunday, whatever the cause of the ongoing blow out in Libor-OIS, this move is having defined, and adverse, consequences on both dollar funding and hedging costs. This alone will have a severe impact on foreign banks, because as DB wrote recently, "the rise in dollar funding costs will damage the profitability of hedged investing and lending by [foreign] financial institutions. Most of the bond investors we have talked with shared a strong interest (and concern) in this topic." However, the most immediate consequence is that it is now more economical for Japanese investors to buy 30Y JGBs, with their paltry nominal yields, than to purchase FX-hedged 30Y US Treasuries which as of this moment yield less than matched Japanese securities. The same logic can be applied to German Bunds, as the calculus has made it increasingly unattractive for European investors to buy FX-hedged Treasuries. Meanwhile, in the forward space, the latest jump higher in 3-month USD Libor prompted a fresh wave of selling across Mar18 eurodollar futures... ...with the higher fix pushing FRA/OIS over 50bp for the first time since 2012. And while Libor-OIS is moving fast, the FRA/OIS has widened even more dramatically, rising as much as 8bp above spot Libor-OIS in recent days. Aside from reflecting expectations of a wider Libor-OIS, the FRA/OIS widening could have been driven by the fact that large traders used Eurodollars instead of fed funds futures to express views of a more aggressive Fed cycle and a higher terminal rate. An evidence of this is that FRA/OIS moved considerably wider the day after the January jobs report and also after the January CPI report. As previously, we urge readers to keep a close eye on this sharp move wider, because whether it is due to relatively innocuous reasons such as the 4 listed by BofA, or the three far more troubling ones, namely i) the risk premium for uncertainty of US monetary policy, ii) recently elevated credit spreads (CDS) of banks and iii) demand for funds in preparation for market stress, dollar funding is becoming increasingly problematic, and absent a sharp tightening in the Libor-OIS and FRA-OIS spread, while bank credit concerns may not have been the catalyst for the sharp spike, it will be banks that are eventually impacted by what is increasingly emerging as an acute tightening in short-term funding markets and/or a global dollar shortage. What happens next is critical. As BofA notes, it is difficult to imagine levels moving materially higher than 50bp due to the presence of central bank liquidity swap lines. The Fed currently maintains bilateral FX swap lines with the ECB, BoJ, and other major central banks. The price to access these swap lines has three parts: (1) OIS of borrowing tenor +50bp; (2) haircut on the posted collateral; and (3) associated stigma. As such OIS +50 should serve as a soft upper bound on how high funding costs can rise though it is certainly possible the 3m L-OIS spread could rise to 60bp after collateral haircuts and stigma concerns are taken into consideration. As such, should either L-OIS, or FRA-OIS move notably wider beyond 50bps, and should CB swap lines remain unused, it may be time to throw away all those explanations you have read that say "don't panic" the move is perfectly normal, and to consider the alternative. Finally, the move in Libor alone will soon start attracting attention as it is the benchmark rate for several hundred trillions in floating-rate debt. It is worth noting that the Fed itself is monitoring the rise in LIBOR and is trying to understand what exactly is driving it (in their most recent dealer survey the Fed specifically asked about the 3m L-OIS spread widening). The Fed is certainly aware that the around 35bp increase in 3m LIBOR-OIS since mid-November equates to roughly 1.4 hikes. However, according to BofA, the Fed is probably monitoring LIBOR in the context of broader financial conditions and is not yet sufficiently concerned by the recent tightening to adjust policy. Indeed, the Chicago Fed financial conditions index has tightened, but still shows conditions are much easier vs when the Fed started tightening policy in 2015. The Fed would likely be much more concerned about the rise in LIBOR if it reflected heighted bank credit concerns rather than structural supply/demand dynamics at the front end of the rates curve... which may well be the case if as noted above, the blowout persists beyond 50bps. They will also likely become concerned with financial conditions only if it spills over into broader corporate borrowing/investment activity or begins to wane on consumer or business confidence. Overall, consensus believes that the rise in LIBOR is not yet sufficient to derail the Fed from their "gradual tightening cycle", but they will likely be more attuned to financial conditions given the recent rise.
Honeywell (HON) UOP introduces ULTIMet catalyst to help refiners better meet industry norms through hydrotreating process efficacy and cost control.
Marvel’s groundbreaking film profits from the dearth of new releases, while renewed controversy for Woody Allen may have affected his latest Wonder Wheel A commercially impotent set of new releases last Friday ensured that Black Panther remained unchallenged at the top of the UK box office for a fourth week, with weekend box office of £2.93m. After 27 days, the title’s cumulative box office has reached £39.8m – ahead of the lifetime total of every Marvel film accept Avengers Assemble (£51.9m) and Avengers: Age of Ultron (£48.3m). Continue reading...
Having earlier sold 3Y Notes and 6M Bills to a surprisingly eager market in two rather strong auctions, at 1:01pm the Treasury concluded today's sale of $145 billion in paper, with the sale of $51BN in 3M Bills and $21 billion in 10Y Notes, in two more strong auctions. The high yield of 2.889% was on the screws with the When Issued, and 9bps above February's 2.811%. It was also the highest yield since January 2014. The Bid to Cover was 2.50%, above last month's 2.34 and also above the 2.45% auction average. The internals were also on the strong side, with the Indirects taking down 66.2%, which slightly below February's 67.5% was above the 6 month average of 64.8%. Directs were awarded 6.5%, just higher than the 5.4% last month, leaving 27.3% for Dealer. Separately, the Treasury also sold $51.0b in 3M bills, at a bid-to-cover of 3.13, well above the 2.95 6 auction average. And refuting speculation that foreigners are fleeing Bills, Indirect bidders were awarded 44.7% of the takedown vs six previous auction average 41.5%. Overall, today's massive supply was soaked up without a glitch, and with far less concessions than many had expected. As a result, the TSY complex held gains after today's auctions, with muted price action following the 10Y auction, and with the 10Y yield lower on the day by ~0.5bp.
Starting today's barrage of Treasury Bill and Note supply, which will see $145BN in 3M and 6M Bills, and 3Y and 10Y Notes, moments ago the Treasury sold $28BN in 3Y notes in what was a surprisingly strong auction. This was the biggest 3Y auction since June 2014 as the Treasury begins to pre-fund the surging US budget deficit. The auction high yield of 2.436% stopped through the When Issued 2.438% by 0.2 bps. It was the highest yield since May 2007 (when it was suspended until November 2008), and well above last month's 2.28%. The bid to cover of 2.94 was fractionally below February's 3.00%, but just above the 6 month auction average of 2.93. The internals were solid, with Indirects taking down 50.0%, above last month's 49.8%, but just below the 6M average of 52.9%. Directs were awarded 9.3%, above the 6 auction average of 9.2%, leaving Dealers holding 40.7%, virtually identical with last month's 40.5% if slightly above the recent average of 37.9% At the same time the Treasury also sold 6Month bills which saw a spike in demand, with the Bid to Cover jumping 3.67%, well above the previous auction's 3.19. As Bloomberg notes, the auction was expected to benefit from outright yield and curve valuation, while negatives include increased size, biggest since June 2014. In the end the positives appear to have won, and overall it was a solid start to today's mammoth issuance, which will see 3M and 10Y auctions pricing in just under 90 minutes, at 1pm ET.
Danaher (DHR) to buy Integrated DNA Technologies to expand into the genomics research market.
Call it the latest paradox of bizarro centrally-planned markets. On the same day when the Nasdaq hit a new all time high, when the Dow soared and when the payrolls report reincarnated the Goldilocks narrative with one flashing red average hourly earnings headline ("surging jobs + subdued wage growth = an economy that can handle 10Y yields at or above 3.0%"), one of the most closely followed leading indicators of an imminent funding crisis and global credit crunch finally broke above its 6 year range, when the USD Libor-OIS spread jumped 2bps on Friday, rising to 44.23bps. This was the widest this key spread has been since January 2012, when the latest European sovereign debt crisis was roiling the markets and forced the Fed to open unlimited swap lines with the rest of the world to avoid a global dollar funding crisis and, well, effectively bail out the world - which according to the BIS is synthetically short the USD to the tune of over $10 trillion - for the second time in 4 years. The move will not come as a surprise to regular readers, as we have been covering it extensively since late 2017: Why US Tax Reform Will Put Even More Pressure On Dollar Funding Markets Libor-OIS Blowing Out On Rising Repatriation Concerns, Collapsing Front-End Funding Libor-OIS Contagion: As Spread Blows Out, It Starts To "Infect" Other Markets Libor-OIS Blows Out As Libor Rises Above 2% For The First Time In 10 Years However, while the overall move wider was expected, the speed of the blow out has taken most analysts by surprise, and the result has been a scramble to explain not only the reasons behind the move, but its sharp severity. While this is a simplification of the various catalysts behind the spike in Libor-OIS, here is a quick summary of what is going on - the expansion of Libor-OIS and basis swaps have been impacted by a complex array of factors, which include: an increase in short-term bond (T-bill) issuance rising outflow pressures on dollar deposits in the US owing to rising short-term rates repatriation to cope with US Tax Cuts and Jobs Act (TCJA) and new trade policies, and concerns on dollar liquidity outside the US risk premium for uncertainty of US monetary policy recently elevated credit spreads (CDS) of banks demand for funds in preparation for market stress In recent posts (see above) we have taken a detailed look at each of these components, of which 1 thru 3 are the most widely accepted, while bullets at 4 through 6 are within the realm of increasingly troubling speculation, and suggest that not all is well with the market, in fact quite the contrary. Whatever the cause of the ongoing blow out in Libor-OIS, this move is having defined, and adverse, consequences on both dollar funding and hedging costs. This alone will have a severe impact on foreign banks, because as DB wrote recently, "the rise in dollar funding costs will damage the profitability of hedged investing and lending by [foreign] financial institutions. Most of the bond investors we have talked with shared a strong interest (and concern) in this topic." However, the most immediate consequence is that it is now more economical for Japanese investors to buy 30Y JGBs, with their paltry nominal yields, than to purchase FX-hedged 30Y US Treasuries which as of this moment yield less than matched Japanese securities. The same logic can be applied to German Bunds, as the calculus has made it increasingly unattractive for European investors to buy FX_hedged Treasuries. It's not just rates: the consequences of rising dollar funding costs will eventually impact every aspect of the fixed income market, even if simply taken in isolation due to the ongoing spike in 3M Libor which still is the benchmark reference rate for hundreds of trillions in floating-rate debt. The reality, however, is that without a specific diagnosis what is causing the sharp surge wider, and thus without a predictive context of high much higher it could rise, and how it will impact the various unsecured funding linkages of the financial system, it remains anyone's guess how much wider the Libor-OIS spread can move before it leads to dire consequences for the financial system. * * * And while we wait to see if this sharp move will continue, or it will moderate and perhaps reverse, here is a useful primed courtesy of Bloomberg on "why it matters that the Libor-OIS spread is widening." Short-term borrowing costs in the U.S. have risen to levels unseen since the financial crisis, and recent moves in two closely watched indicators -- the London interbank offered rate and its spread with the Overnight Index Swap rate -- are causing some consternation. The spread has expanded to its widest level in more than a year, raising questions about whether risks might be brewing within credit markets. While the recent widening may be technical and doesn’t suggest a systemic risk, several factors in funding markets are likely to prevent a “lasting retracement,” according to analysts. 1. What is Libor? The London interbank offered rate, or Libor, is a benchmark that’s regarded as a gauge of credit market conditions. Every day, various major banks submit to an administrator estimates of what interest rate they would have to pay to borrow in the interbank market, and these are compiled to establish benchmark rates in five different currencies across seven different loan periods. Those benchmarks underpin interest rates on a range of financial instruments and products from student and car loans to mortgages and credit cards. 2. What’s OIS? The Overnight Index Swap rate is calculated from contracts in which investors swap fixed- and floating-rate cash flows. Some of the most commonly used swap rates relate to the Federal Reserve’s main interest-rate target, and those are regarded as proxies for where markets see U.S. central bank policy headed at various points in the future. 3. Why does the Libor-OIS spread matter? It’s regarded as a measure of how expensive or cheap it will be for banks to borrow, as shown by Libor, relative to a risk-free rate, the kind that’s paid by highly rated sovereign borrowers such as the U.S. government. The Libor-OIS spread provides a more complete picture of how the market is viewing credit conditions because it strips out the effects of underlying interest-rate moves, which are in turn affected by factors such as central bank policy, inflation and growth expectations. 4. Why are people worried? The Libor rate for three-month loans in dollars has climbed to 2.03 percent, a level it hasn’t reached since 2008. Its spread over the OIS rate has also widened quite dramatically following a Congressional deal on the U.S. budget and debt ceiling on Feb. 8. That gap widened by 15 basis points in February and was at 44 basis points on March 9. It is the speed of the move that is giving some investors pause for thought. 5. What pushed it up? Several factors. One has to do with the torrent of Treasury bill supply that the government has unleashed since lawmakers last month resolved their impasse over the nation’s borrowing limit. With that crisis passed, the Treasury has been replenishing its cash balance and that has meant a flood of debt sales, particularly of shorter-dated securities. That has driven up borrowing costs not just for Uncle Sam, but also for other borrowers in the short-term market who rely on instruments such as repurchase agreements and commercial paper. 6. So that’s the only reason it’s widening? No, the tax legislation passed by Congress in December is also playing a role. The new law offers incentives forcorporations to bring money back to the U.S. that they had previously stashed overseas. Much of that offshore hoard has tended to be kept in short-term instruments like commercial and bank paper, and a dwindling of those overseas cash piles is likely to mean reduced demand for these products. And that means higher borrowing costs. 7. Anything else? Yes. The Federal Reserve is shrinking its $4.4 trillion balance sheet, which means there will be less reserves sloshing around in the financial system. As the U.S. central bank pulls back from providing support, banks are going to have to compete more for funding, and that could force short-term rates higher.
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