The last few days have seen the credit risk of the world's largest prime brokers (and SIFIs) cracking wider, breaking above key technical levels and trendlines, to their widest (most risky) level in six months.
And on average, the big financial firms are at six-month wides, breaking downtrends and critical technical resistance...
This is happening as US financial stocks rebound hopefully (despite a collapsing yield curve), completely ignoring the fact that the market is pricing their business risk in the credit markets dramatically deteriorating...
And it is becoming very clear that the blowout in Libor-OIS that we have been detailing...is starting to spread contagiously into bank credit risk as short-term funding stress sparks a lagged response...
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.
This is not going to end well.
But it's not just affecting US markets. As Bloomberg reports, the surge in Libor is impacting funding markets worldwide.
From Riyadh to Sydney, short-term funding markets worldwide are starting to feel the effects of soaring U.S. dollar Libor rates.
Libor’s rise is complicating Saudi Arabia’s efforts to stem the risk of capital flight as the Fed is poised to continue raising rates.
Rising Libor is also fueling uncertainty surrounding Hong Kong’s peg to the U.S. dollar. The benchmark is 117 basis points above Hong Kong’s interbank offered rate, or Hibor, the widest gap since 2008.
The increase has pushed the local currency to the weak end of its band versus the dollar, spurring speculation the Hong Kong Monetary Authority will step in.
Down Under Too
The leap in Libor is also being felt in Australia’s financing markets. It’s made overseas borrowing more expensive for the country’s banks, which could push up domestic issuance, TD strategist Prashant Newnaha said in a note last week.
As a result, short-term funding costs for Australian banks are set for their biggest monthly increase since 2010.
* * *
The key is whether rising Libor rates will fuel a funding crisis - something we have been worrying about all year (as we detailed above with the blowout in the Libor-OIS spread)...
“We usually don’t see this kind of divergence in rates without some sort of credit issue,” said Margaret Kerins, head of fixed-income strategy at BMO Capital Markets Corp., referring to Libor’s rise versus OIS.
“At what point does all this become damaging and how far does it go? That is the issue.”
It appears to be damaging now..
“There has been sort of the perfect storm of factors tightening financial conditions,” said Russ Certo, head of rates at Brean Capital in New York.
“Banks do have tremendous liquidity still, but it’s at a higher price.”
But, but, but... "fortress balance sheets"?