Markets wary of rise in US bank funding costs

THREE-MONTH LONDON INTERBANK OFFERED RATE HAS RISEN RAPIDLY

Asurge in US shortterm bank funding costs, traditionally a key gauge of stress, has grabbed the attention of investors who are trying to assess whether it has wider ramifications for international markets.

The three-month London interbank offered rate (Libor) has risen rapidly, with its premium above the overnight index swap (OIS) hitting 58 basis points yesterday, its highest since May 2009.

Here are five pressure points that investors are watching to see if the surge escalates into a global dollar funding crisis.

Non-US dollar costs

A blowout in the US Libor-OIS spread hasn’t been accompanied by a widening in equivalent spreads in other currencies such as euros, Japanese yen or sterling.

Investors say this shows there is no widespread rush to secure cheap funds elsewhere.

“If this was a crisis sign in the market, then we would see other spreads blow out as well at the same time, which we saw in the last financial crisis and in the euro zone crisis,” Tim Forster, portfolio manager at Fidelity International, said.

Currency hedges

One of the first places where a rush for dollar funding escalates is in the arcane but deeply liquid world of currency basis swaps, used by institutional investors to hedge their foreign bond investments. During the 2008 financial crisis and the 2011-2012 euro zone debt crisis, banks, especially non-US institutions that found themselves shut out of the US interbank markets, tapped the currency swaps markets in euros and yen and exchanged them. But this time around, funding pressures are absent.

Corporates

Instead of seeking dollars in US money markets to fund their international operations, European corporates could issue more dollar-denominated debt at home.

With Libor, a reference rate for $200 trillion worth of dollardenominated financial products, at its highest since 2008, analysts say a pickup in dollar-denominated bond issuance by European corporates, especially banks, may follow. This week has seen HSBC, Europe’s largest bank, and Germany’s NRW Bank issue dollar-denominated debt.

A surge in outstanding US. Treasury bills to a record $2.3 trillion has also put upward pressure on short-dated US bond yields — something analysts say is crowding out money market funding and forcing issuers of commercial paper to offer higher spreads amid generally rising rates.

Central banks

One concern is that higher US borrowing costs, if they persist, could tighten financial conditions and potentially reduce how aggressively the Federal Reserve raises rates. The same could be true for the euro area as tighter US financial conditions spill over into Europe, possibly delaying the European Central Bank’s timeline to exit stimulus. A firm euro has already contributed to tightening eurozone financial conditions faster than the ECB would like.

US dollar

Citibank says the dollar-Libor/OIS spread has in recent years proved a good leading indicator for the dollar index, which measures the greenback’s performance against other major currencies. Wider spreads tend to lead to a stronger dollar, with a three-month time lag. “We are still forecasting dollar weakness on fundamental grounds,” the bank said. UAE 24 ct Gold/10g +0.93%