I’m starting this post out with a tweet:
Behold, the kink in question:
You can see the spread between dollar and euro Libor is upward sloping up to 6mths, then falls at the 1yr point on the curve. The question is why.
To answer that, I started looking at the points in the Libor curves to see what the trade-off was between maturities and basis points paid at the various maturities. So here are the charts, which I hope to explain in a cogent manner:
Here’s how I created these:
- Collect rates at Libor curve maturities (o/n, 1mth, 3mth, 6mth, 1yr)
- Calculate the basis point differences between the maturities (1mth-o/n, 3mth-1mth, 6mth-3mth, 1yr-6mth)
- Plot over time. Voila.
Another way to view the data is to look at the basis point differentials as curves themselves. That’s what I did with these two:
Two things to note: I circled the rise in dollar Libor at the 3mth-1mth differential and the 6mth-3mth differential, but it’s also worth noting the rise between the 3mth-1mth and 1mth-o/n differentials, too. It shows me the fear in the dollar Libor market is squarely in the o/n-6mth time horizon, even while the whole curve has shifted upward. Meanwhile, euro Libor differentials have stayed anchored like a ship run aground with the exception of May 11, where o/n euro Libor spiked for some unknown/undisclosed reason. My guess then was that either a bank had a funding problem or someone else was really bidding overnight funding up, just to stay liquid for 24 hours. Either way, not a good sign.
Plus, the euro Libor curve shows a bit of a kink between the 6mth-3mth and 1yr-6mth differentials. It could be that there’s a preference to get 1yr funding over 6mth, but it’s hard to say.
At any rate, what we can conclude is pretty clear: dollar Libor is where the action is and until we see these differentials at the front end of the curve relax, the bear flattener is on.