Category Archives: Monetary

Whether It’s Euribor or Libor, It’s All IBOR All the Time

I wanted to expand on the issue going on in Europe with respect to funding.  I’ve been contending the situation is getting worse, not better.  And as a result, we’re seeing a blow-off coming in the Euro, which in spite of the recent “strength” we’ve seen, has some very fundamental issues and it’s questionable it will continue to exist in its current form.

But first, I wanted to present a more comprehensive view of the term structure of Dollar/Euro Libor spreads:

The telling thing here is the fact that the short end has risen much higher than the long end, so this is a bear flattening in action.

I should probably explain why I look at the spread between Dollar and Euro Libor rates in this manner.  Here’s why (emphasis, mine):

In response to the reemergence of strains in U.S. dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the reestablishment of temporary U.S. dollar liquidity swap facilities. These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers. The Bank of Japan will be considering similar measures soon. Central banks will continue to work together closely as needed to address pressures in funding markets.

via FRB: Press Release–FOMC statement: Federal Reserve, European Central Bank, Bank of Canada, Bank of England, and Swiss National Bank announce reestablishment of temporary U.S. dollar liquidity swap facilities–May 9, 2010.

That was all about this:

The purple circle goes back to the start of the sovereign debt crisis.  What nobody was talking about then was the sell-off in the Euro being driven by funding concerns with banks.  I wrote a post back in May where I came to the realization that these events are all about banks trying to fund themselves in the most relevant currency they can use.  To try and illustrate that, let’s take a look at the direction of those Libor spreads and the EURUSD exchange rate.

First, let’s take a look at a longer term daily EURUSD chart:

So you can see there was a bounce in early June and the Euro has been riding it ever since.  To get better visibility into what happened, here’s another EURUSD chart over a shorter timeframe:

Note the sharp break in the uptrend and change in trajectory of the rally.  But I want to focus on the beginning of the uptrend, June 8.  You can see what was happening to the spread between dollar and euro Libor:

Right around that time frame, spreads started widening.  So as funding was getting scarce,

Meanwhile, here is a look at Euribor curves going back to the beginning of the year:

One of these days I’m going to get something up and running and treat these properly by plotting them out as 3D surfaces to look at.  But that day is not today.  Regardless, you can see the curve is having some dramatic shifts out. Again, developing a 3D surface of Euribor, euro Libor and dollar Libor would probably help us in thinking this through to understand what’s going on.

But in the meantime, here’s are a couple of graphs of Euribor/Euro Libor spreads:

The humped nature of the spread curve indicates to me there are issues in the front-end of the curve out to 3mths and then they relax.

I’m curious as to why it happened, but I’m almost certain someone smarter than me is already working on it…

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Libor and the Bataan Death March for European Banks

I’m a little late in getting this out, but the charts will speak for themselves:

That was just the actual Euro Libor curve.  Here are two ways to look at Euro Libor funding relative to Dollar Libor:

The pace of widening between Euro-denominated Libor and dollar-denominated Libor has dramatically increased over the past week or two.  And if you take a look at the EURUSD chart:

You can see the Euro low was set in June which coincides with the increase in Euro-denominated Libor.  What I am sensing here is a surge both in the Euro and rates being driven by the liquidity crunch in Europe that’s building to some sort of apex at which point the true nature of the deflationary, lackluster conditions present there will be visible to everyone.  So that means you can add Europe to the list of economies that will be dealing with a significant overhang of deflation/deleveraging.

Longer term, this is setting itself up to be the Deflationary Derby: Japan, the US, Europe and other participants to be named at a later date.

But before we get there, there are some banks in Europe that are bound to be casualties of the ongoing liquidity squeeze we’re seeing.  Something like the Bataan Death March in WWII: the soliders taken prisoner by the Japanese had no food and water.  The banks have no commercial paper and little to no short-term funding. 

But both have one thing in common: they happened under the hot, sweltering sun…

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Paul McCulley does Modern Monetary Theory | Credit Writedowns – And My Thoughts

I’ve been trying to make sense of the macro landscape since, well, that’s just what I do.  One of the frameworks I’ve been trying to learn more about is Modern Monetary Theory, but I have to admit it has been a bit of a mind-bending experience and I’ve not always had the greatest success getting my head around it.

Having said that, when I read about Paul McCulley of PIMCO doing MMT, I wanted to see what I could find out.  So I wrote up a question for Edward Harrison at Credit Writedowns, who I have a great deal of respect for:

Interesting stuff. Edward, I have two questions for you:

1) I agree with you about this being a secular change in aggregate demand instead of a cyclical change. So in your mind, will the MMT approach work? Maybe you said it already, but perhaps you could re-state.

2) China taking on the consumer of last resort makes sense given their surpluses. Do you think the news regarding the Dagong’s rating of the US vis-a-vis China is about getting cheaper costs of funds to take this role on or is about capital inflows because credit and real estate are facing headwinds there now?

Thanks as always.

via Paul McCulley does Modern Monetary Theory | Credit Writedowns.

Here’s Edward’s response:

Yes, MMT works. But, remember MMT is just a framework -a lens – through which to view actual economic events. It is a very useful framework though because it forces one to look at all individual transactions or any aggregate shift as having two parties with balance sheet effects.

If I reduce my purchases from you that has implications not just for me but for you too. A lot of politicians try to talk about the budget deficit in a unitary way without working through the numbers.

This still doesn’t get away from the longer term problems regarding the (mis)allocation of real resources (monetary and physical). But it doesn’t allow people to cheat intellectually and act like austerity will be positive for the economy.

I was actually in bed when I saw this via my friend Scott and got up just to write a quick blurb on it. So I am headed back there now! More in the morning.

Looking forward to what he has to say on this…

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And So It Begins…

I asked people about a scenario like this unfolding two years ago and was looked at like I had three heads…

The financial calamity of the European Union’s sovereign debt woes has shaken the pillars of the postwar ideal of a united Europe. The debt crisis and the global downturn have left many European countries looking inward these days and viewing Brussels as increasingly irrelevant.

Germany, long a postwar champion and financier of European integration, is flexing its muscles more independently. And more of its citizens are questioning the country’s leading role in the European project.

On a recent day, Christian Gelleri buys a sandwich and a glass of Hefeweizen at a rustic, sun-filled outdoor beer garden along the Inn River in the Upper Bavarian town of Stefanskirchen.

But the 40-year-old isn’t paying with euros. The bar also accepts chiemgauer, the thriving local currency named after a region in Bavaria.

via From Stalwart To Skeptic, Germany Rethinks EU Role : NPR.

Me and my other two heads aren’t looking so out of place anymore, I gather…

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While Euro Libor Gently Weeps

In my mind there’s not much else to say about Libor in the Eurozone.  The charts do all the talking for me:

The curve is shifting out at a rapid pace, in a bear steepening fashion.  Looks like liquidity situation in Europe is getting worse, which keeps the Libor rates moving upward rapidly. And the Euro has followed suit:

This brings up an interesting point about the risk-on/risk-off trade: it depends on who you’re talking about.  For most people in the world, the risk-on trade is to hold anything except dollars.  Risk-off is to convert those holdings into dollars. For European banks, however, they have to convert everything back into Euros.  So with the removal of Euro-denominated liquidity facilities, “risk-off” takes on a different meaning.

Regardless, the funding squeeze continues…

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A Bip A Day Keeps The Counterparties Away: LIBOR Update

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.

St. Augustine
more famous quotes

I think banks in Europe are starting to find out just how true that saying is…

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Obscure Rates Update

Because Libor rates aren’t obscure enough, I’m taking a quick look at EONIA swap rates and the EONIA swap curve.  This first chart is really busy since I put all the maturities on one chart going back to January, 2008.

I then took the data and tried to boil it down in terms of just looking at relatively recent experience with fewer maturities.  You’ll see over the past few weeks all maturities have seen an increase in rates.

This next chart takes a look at the EONIA swap curve.  I took daily snapshots for the past several weeks.  Again, it’s a little busy:

But why is EONIA important?  It’s important because it is used as the reference rate for interest rate swaps throughout the Eurozone.  So banks, insurance companies, multinational companies and others use it to either fix or float their borrowing costs, depending on their capital structure, how they want to achieve their weighted average cost of capital (WACC) objectives, etc.

Note the arrow I put in the chart.  You should see a kink where the longer dated rates widened from previous fixings and look to steepen.  Since most swaps are done in annual increments, I tend to focus more on longer dated curves  so the 1 yr and 2 yr swap rates are what I’m interested in the most.  Another sign Euro-denominated funding is getting more expensive.

Here’s another obscure rate to keep track of.  It’s actually a spread instead of a rate, but it’s still important: it’s the spread between 2yr Treasuries and 3mth Libor:

This one is interesting because of what it infers.  From David Goldman:

If LIBOR continues to creep up and reaches, say, 75 bps, it no longer will be economical for banks to own US 2-year notes. In that case the US Treasury market will be in trouble. That’s when you head for the bomb shelter.

via Inner Workings » Blog Archive » …unless LIBOR hits 75 bps, in which case head for the shelter.

That was written a little while back when dollar Libor was moving higher, almost unabated.  Now, it’s not moving much at all but the issues is still the same: it’s one of potential yield curve flattening/inversion and counterparty credit risk.  A quick check of rates as of July 1 shows the spread at about 10bps.  Precariously close to parity.  The green circle is from July ’05 and it was the first time the spread went negative – right around the same time housing peaked. So this can be a good tell regarding overall market conditions, but it’s not watched that frequently.

So bottom line: counterparty issues are taking center stage again, and as a series of fundamental macro metrics, they don’t look that good to me.  Growth looks like it has stagnated and is possibly contracting, job growth is weak at best and other metrics aren’t looking so cheery.  As this backdrop has really lingered since ’07 – with the conditions that set all of this up occurring beforehand – it’s probably time to think about what to do about it.

Yes, that means I’m going to look at the inflation/deflation, austerity/stimulus debate.

You’ve been warned…

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