SOMETHING RATHER ODD is happening in the money markets. Libor is through the roof. It’s supposed to be a temporary spike based on US money market funds avoiding pending regulation, but I wonder.
It’s a bizarre bifurcation. Long-end cash markets in US Treasuries and Gilts are heading towards negative rates. But at the same time there is a credit squeeze on the rate of interbank borrowed money, while reference rates are going definitively negative.
Having hovered around the 0.3% mark for most of the past three years, three-month dollar Libor has been under upward pressure since the year began. The recent spike has taken it to 0.81%, its highest since May 2009. The theory is that investors have steered cash away from money market funds due to regulations that will go into effect later this year, and that this spike is temporary.
That’s one theory doing the rounds. The other is that in the face of negative rates in yen and euros, the hunger for dollars is creating a global shortage of the greenback and that short-term money markets are charging more for the privilege of holding the currency. Whatever the reason, the effective tightening of liquidity at a time when a third of the world’s bond markets are yielding negative returns presents cause for concern.
THE LIBOR SPIKE reminds me of the drying-up of the asset-backed commercial paper market just prior to the start of the global financial crisis, when short-term liquidity seized up and panic set in.
Of course you could argue that the London Interbank Offered Rate has had its day. It must be the only financial market acronym with which the man in the street is familiar, having seen rogue bankers heading to jail as the result of fixing the rate.
Indeed the manner of its setting, according to rate submissions from a limited coterie of banks, has always been somewhat dodgy. I look back to my days as a institutional bond salesman in London, when the traders would show their axes which could potentially be asset-swapped.
They’d point out the lowest Libor quote, which could be as much as an eighth of a percentage point lower than the consensus on the screen submitted by other banks. If your client was a buyer of paper at say Libor plus 20bp or above, you were off to the races thanks to that one seemingly aberrant quote.
Time, perhaps, for a reference rate that is determined purely by market forces rather than via the rates submission method with all its sullied associations. That’s been the call in numerous circles, and the spike will only make that call louder.
Still, a ramping Libor is not all bad news for the banks. Reams of dollar-paying swaps have shot up in present value terms and have been – or are in the process of being – unwound for a handsome gain. And while most banks’ net interest margins have been falling, loan books will be looking healthier as floating coupons head higher.
Of course the corollary to that is increased debt service stress, and all the Libor-referenced coupon fixes this year on bank loans will have caused more than a few corporate treasurers sleepless nights. Nowhere is this more relevant than in Asia, where defaults are creeping stealthily back into the financial market equation, even in places as pristine as Singapore.
Looking at the region’s lasting addiction to dollar funding, I’m reminded of the roots of the Asian financial crisis in the 1990s. The chaos back then was blamed on the double mismatch of currency and tenor, and it’s long been assumed that Asia has learned its lesson via the development of local bond markets and long-tenor domestic funding. There’s some truth in that, but dollar debt has still been the funding choice for reams of the region’s corporations.
We can only hope that we are not about to witness a re-run of 2008 or indeed of 1998 in Asia
NOW IMAGINE AN unpleasant scenario, where the spike in Libor is a function not of impending regulations but of a general leeriness towards providing credit. It’s already been estimated that with around US$7trn of global debt, including mortgages and bank loans tied to Libor, the move north in the rate this year has added around US$15bn to global debt servicing costs. A move towards a 1% handle and beyond would inflict severe stress.
As far as Asia is concerned you can take India as a prime example of how much that would hurt. Its state-owned banks are mired in a mountain of bad debt and require a full-scale recapitalisation. Non-performing dollar loans are being written off at a rate of knots but a further spike in Libor could render that situation catastrophic.
We can only hope that we are not about to witness a re-run of 2008 or indeed of 1998 in Asia. Of course, negative bond yields were the stuff of fantasy back then, but they are very much the reality now. As Gilts briefly went negative last week for the first time in their illustrious history, it served to emphasise that these are highly unusual times wherever you look on the global yield curve. Whatever the reason for Libor’s recent misbehaviour, markets have every right to feel rather scared.