"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.


FireBrander Fri, 03/16/2018 - 13:04 Permalink

Higher mortgage rates coming up!

Never been a better time to buy a house!

Buy now or be priced out!

What other cry am I missing from the "Home ownership" barkers?

Not Too Important Four Star Fri, 03/16/2018 - 13:15 Permalink

"...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."

So, some foreign Central Bank staffer is instructed to hit his numeric keypad dozens of times (creating money) to send to the Fed, and another staffer at the Fed is instructed to hit his numeric keypad dozens of times (creating money) to send back to them. With absolutely no requirement to prove to anybody that anything at all ever gets paid back. In the meantime, US taxpayers continue to provide tax dollars to pay back whatever 'loans' the Fed said they created, again with no requirement to prove a thing.

Got it.


In reply to by Four Star

FireBrander FireBrander Fri, 03/16/2018 - 13:09 Permalink

Previous topic..that Florida (experimental) Bridge Collapse.

No White male "European sounding names" on the research team; imagine the outcry if that was reversed...no "Muslim sounding names" allowed on the team..

Key Researchers

Atorod Azizinamini, Ph.D., P.E.
Professor and Chair; ABC-UTC Director
Education:  Ph.D., University of South Carolina-Columbia, 1985
Specialty:  Structural and Bridge Engineering


Mehmet Emre Bayraktar, Ph.D.
Associate Professor
Education:  Ph.D., Purdue University, 2006
Specialty:  Construction Decision and Risk Analysis

Atorod signed off on the design and Mehmet calculated that it wouldn't fall down....FAIL!

The whole crew: https://abc-utc.fiu.edu/about-us/key-researchers/


I'm not a bridge engineer, but just looking at the bridge design tells me there is an IMMENSE amount of stress/weight in the very center of that span; yet the center doesn't appear to be any more reinforced than the rest of the bridge? Interesting that when they transported the bridge, they supported it in the center area...why?...worried it would snap while moving it to the installation site?...red flags right there.

If you read their mission statement...not a word about cutting edge structural integrity...

" The mission of the ABC-UTC is to reduce the societal costs of bridge construction by reducing the duration of work zones, focusing special attention on preservation, service life, construction costs, education of the profession, and development of a next-generation workforce fully equipped with ABC knowledge. "



Found one white guy involved the project..he's just a kid, fresh out of "College"...ink on his degree is still wet...

"The ABC-UTC would like to congratulate Samuel Redd (MS, ISU) for winning the 2017 UTC Outstanding Student of the Year Award. Sam completed his MS from Iowa State University in December 2016. His research was focused on the laboratory testing of integral abutment details for ABC. This research studied the strength, durability and constructability of two ABC integral abutment details through laboratory testing".

Funny, the only part the didn't fall down, the abutments, was the White Guys' job...



In reply to by FireBrander

Rex Andrus FireBrander Fri, 03/16/2018 - 13:41 Permalink

Gatekeepers man. You get to pay for it but you can't get in. I had an engineering math class at a state U. The towelhead next to me turned in blank quizzes, the towelhead TA gave him As on his quizzes. On my way out I got as far as lawyers. My story is not unique.

In reply to by FireBrander

Winston Churchill FireBrander Fri, 03/16/2018 - 14:57 Permalink

Maybe putting a suspension bridge arch up before the suspension tower is there  to rig to was a fatal mistake.

SoP is to do it the other way around.Maybe the instructions were upside down and in English, not Spanish.

I'd like to see the contract and if the contractor got a big draw for flying that arch,my guess is yes.

In reply to by FireBrander

detached.amusement FireBrander Fri, 03/16/2018 - 15:36 Permalink

its amazing that it made it out of the design lab, much less got approved by zoning...one look at that bridge tells anyone that has remote structural knowledge that the trusses were designed for style rather than anything resembling structural support.


one has to be single truss collapse theory believing stupid....

In reply to by FireBrander

Ink Pusher FireBrander Fri, 03/16/2018 - 13:41 Permalink

Backstage preamble:

We'd better sell this shit before the imminent credit implosion occurs.

Private Money Rates will go through the roof and head for the Moon overnight.

I wonder how many swaps will be acquired on default this week?


In reply to by FireBrander

Giant Meteor BandGap Fri, 03/16/2018 - 13:50 Permalink

All the smart money guys say this ain't anything like the last go round. Nothing to be overly concerned about. So, I'm sure it'll be just fine ..

Structural Change: What is the explanation for the unilateral rise in LIBOR in recent months? The short answer is that new regulations in the money market mutual fund (MMMF) industry appears to be the primary catalyst. These new SEC regulations were a direct consequence of the 2008 financial crisis, and designed to provide additional safeguards for global money markets during times of financial crisis. These new regulations will be implemented on October 14, 2016.

[3] SEC Regulation: The key provision in these new regulations is the requirement that institutional prime (credit) money market funds report net asset values (NAV) on a floating, rather than fixed basis. The key implication is that the daily prices of these funds will fluctuate along with daily changes in market conditions.

Breaking the Buck: The most relevant ramification of this regulation is an increased potential for these funds to “break the buck” — a circumstance whereby the investment income of a MMMF declines to a level below that of operating expenses and fund losses, thereby causing the NAV to fall below one dollar. The primary concern of regulators is that turmoil in the money markets will be the catalyst for increased systemic risk in the global financial system as occurred in 2008 (Lehman) and in 2011 (euro debt crisis).


Ok, ok .. , so that was several lifetimes ago ..

In reply to by BandGap

michigan independant Fri, 03/16/2018 - 13:51 Permalink

Demand for currency hedges is why the basis opens up. Fuck you so pay the risk premium in advance. Eisenhower did it also to slap the children wake up. The Brits almost pissed in the britches and resolved outstanding bitching. Tyler knows all about flows. 



I think The Office need to wake up and solve this petty bullshit with them. Who is more important than why right now and we may never know when they clean up this mess.


buzzsaw99 Fri, 03/16/2018 - 16:49 Permalink

recently elevated credit spreads (CDS) of banks

i thought it was always this.  when in doubt, panic!


forget the ecb and boj, everyone is overlooking the obvious.

This whole thing's very Russian.  [/Art Ridzik, Red Heat ]