Let’s get straight to the charts:
The Euro Libor curve steepened a touch with overnight Euro Libor/Dollar Libor spreads coming in, but the rest of the curve saw another basis point added, resulting in a bit of bear steepening. We’re seeing 3mth and 1yr Euro Libor rising the most, which makes sense. As a result, I’m inclined to believe the Euro rally may have a ways to go. But if you look closely, there may be a top in the process of forming. It would be interesting to see what DeMark indicators can tell us about that:
I also went ahead and analyzed the daily changes in Euro Libor rates:
In every instance there was a flat trend line you could plot until the past two weeks where you can see rates have shot up. To see these changes moving in this manner is bothersome. Rates are moving higher, faster. Part of it can be attributed to rate convexity; as rates increase, they become less sensitive to subsequent rate increases. Having said that, I think we’re seeing the early innings of a liquidity crunch unfold in Europe. Having worked in the Treasury department in a bank, I can say definitively this is why having a solid deposit base is so important. Because if you rely on external funding to get cash to lend, you can – and will – get whipsawed on occasion.
The flip side of the coin is if you have excess deposits and are looking to deploy them. Lending in the interbank market is looking precarious now. It had been precarious before this, with the dollar Libor funding pressures we saw earlier this year telling me you have – as FT Alphaville put it – a two-tiered banking system in Europe. But frankly, I think even the strong banks are running into funding problems and the stresses in both dollar and euro Libor show me a lot of banks have probably been leaning too much on external/brokered funding.
So here we are, three years later, still talking about counterparties, liquidity runs, and bad credit fundamentals in spite of massive central bank intervention. With talk of European banks still being too weak to fund themselves without ECB assistance, a quote from St. Augustine comes to mind:
Habit, if not resisted, soon becomes necessity.
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