Tag Archives: dollar

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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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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The 6.30 Libor Earthquake, Aftershocks and Tsunamis

First, let’s update our Dollar/Euro Libor spread chart.  That’s the one that really matters now because looking at the Libor curves in isolation won’t help us understand what’s going on:

Across all maturities, we saw rates increase about 1bp from Wednesday into Thursday.  Not a healthy sign.  Indeed, I along with others were wondering about the €310bn that didn’t settle and it’s looking more and more like the liquidity it provided is gone and now there’s a mad scramble – a tsunami of buying, if you will – for Euros:

But if you’re watching the Euro-Yen cross like I am, you still need to use the Dollar-Yen as a crossing pair to get a Euro-Yen quote. The last time I checked, the Euro-Yen cross was at 110.039. In a word, ugly.  That cross has been the great carry trade cross for years, so any movements in this cross should be noted and heeded.

But I also wanted to take a look at some other trading activities in futures:

Surely with the correlations we’ve grown accustomed to, a rise in the EURUSD should mean stocks, commodities and well, everything that is not cash is headed higher.  But right now, it doesn’t because of the banking issues in Europe.  Gold collapsing the way it did was rather stunning, frankly.  And the fact that crude oil, in the midst of the summer vacation/driving season coupled with a natural disaster of epic proportions, couldn’t maintain the trend line on the daily chart that would imply $80/bbl, is telling.  And the message seems rather ominous and foreboding:

Meanwhile, two Treasury ETFs, SHY (iShares 1-3 yr Treasuries) and TLT (iShares 20+ yr Treasuries) have benefited from the safe haven bid.  If you executed a bear flattener by shorting the SHY and going long  the TLT, you would’ve had a very nice 6 months, in spite of the gains in the SHY:

My point in showing all of these charts?  It’s to try and present/describe a macro level picture that shows one simple message: the problems in Europe can’t – and shouldn’t – be underestimated and the spillover/contagion/whatever buzzword you want to use that means “spreading” are the worst kinds of scenarios you can think of: higher probability and high severity.  I characterize them as “higher probability” for two reasons:

  1. Never underestimate people’s ability to underestimate tail events.
  2. The probability of a spooky tail event occurring  is increasing.

I don’t know how long the EURUSD “rally” lasts.  It will last as long as banks in Europe are afraid their balance sheets are too illiquid.  It could be over in days, weeks or months.  I don’t know.  But I do know that trade is not acting the same way it would have in the past for a reason.

This will be an interesting month…

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A New LIBOR Update, Expanded Edition

Going forward I’m going to track and summarize Libor data across the three major currencies: Dollar, Euro and Yen.  I’m very keen on looking at this data even though others have pointed out its flaws, which are substantial.  I’ll comment on Don’s excellent work later, because he noticed some things that require some honest answers and I’ll want to touch on those things.

But back to Libor.  First, let’s take a look at all three curves in monthly snapshots based on data compiled by the Financial Times:

Dollar Libor has been on the rise, nothing too dramatic if you’ve been keeping up.  We’ve seen this before.

Euro Libor, remaining stagnant as pond water.  Yes there’s a hiccup in the May 11, overnight rate, but I assume (and it looks like it’s clear now) that was the result of funding/liquidity issues in European banks.

Yen Libor.  What may be of interest to note here is this curve appears to be bear flattening: short rates are rising, longer dated rates are falling.  It’s not much of a move, but given the DV01 we’re dealing with in this day and age, I think it’s worth noting.  Plus, this is the first time I’ve ever looked at Yen Libor, so I’d rather document what I observe than not.  What’s driving it? Muted inflation expectations, muted lending, muted everything at the long end.  Plus, it probably doesn’t help that with carry trades blowing up, we’ve seen more demand for Yen.

Which has lead to some interesting discoveries.  Take a look at the term structure of Dollar Libor/Yen Libor spreads.  For consistency sake, I defined the calculations as foreign Libor minus dollar/domestic Libor.  I could’ve switched the order of the calculation in the Dollar/Yen Libor spread term structure but decided not to.  Here’s the chart:

You can see there had been a downward slope that breaks at 1mth and is less negative to the 6mth point, then turns sharply negative at 1yr.  That’s interesting, because as we look at the term structure of Euro/Dollar Libor spread term structure, it’s kind of like a mirror image:

Right down the kink at the 6mth point.

But the analysis isn’t complete without looking directly at Euro/Yen Libor spread term structure, which I did here.  Here, it’s the Euro Libor rate minus the Yen Libor rate:

This curve has been steepening some.  Spreads at the front end are getting cheaper while longer-dated rates are going up.  This is mostly a function of the bear flattening of Yen Libor we’re witnessing, because Euro Libor rates aren’t going anywhere fast.

Last chart I’m going to present is a weekly chart of the Dollar/Euro Libor spread term structure from May 18 until now:

We’ve seen 6mth and 1yr spreads widen a touch, 3mth has come back down marginally from its recent peak near 54bps.  Whether it’s BaFin or the market has moved on to BP’s plight is anyone’s guess.  I don’t think anything has changed in the underlying structural dynamics, but it’s OK.  We don’t need every day to be a funding/liquidity panic.  It gets draining.


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So A Monetarist Walks Into A Bar… The Futility in Central Banking

I want to follow up some recent posts I wrote on where we are and where we’re potentially headed.  First, I want to offer two pairs of charts, some may be familiar but others may not.  Take a look at the first pair: levels of M3 in the Eurozone and MZM here in the US:

My those sure look correlated.  They show the growth of aggregate money supply over time.  It should be noted money supply growth has plateaued and started turning negative in a pretty significant manner.  These are 30 year charts showing the growth of money supply at an exponential rate.  That trend has been broken.  Rather decisively.

Here’s the same data, presented in annual growth rates:

The fact is these monetary aggregates are shrinking and that shrinking is accelerating.

The question is why.  In a time where stability is but a pipe-dream, why are we seeing this now?  Ideally, money supply should still be growing to foster, as central banks put it, “price stability” and its cousin “financial stability.”  There’s one theory I want to explore, but I may not do a good job of it in any one particular post, so bear with me.  I do have a train of thought, I promise.  It  just might take me a few posts to flesh this out and this is part of the process.

Recall our euro and dollar Libor spread curve where I represent the spread between the two rates as a curve:

The spread is flattening across the curve, and the only way I can see to relieve the pressure is to resume the issuance of central bank liquidity swaps, but so far there hasn’t been much borrowing…

I think we need to see this rise almost parabolically to relieve those funding pressures.  Do we need $600bn like at the peak in September ’08?  Maybe not now, but there may be a need for several hundred billion, as the real sovereign debt issuance is still ahead of us in the months of June and July.  And the potential for banks to re-liquefy their balance sheets seems pretty high.

The question is why haven’t we seen more use.  I have to credit Tom Keene with pointing me to this post from Stanford economist John Taylor.  Anyone who has a monetary policy rule named after them garners my respect, but I have to admit I disagree with him a little on this post:

Note, however, that the recent increase—visible in the right part of the chart—is very small compared with the jumps in 2007 and 2008.

via Economics One: The Fed’s Swap Loans and Libor – OIS Spread.

In absolute terms, yes.  In levels of volatility, yes.  But given the liquidity and money – in the form of debt, mind you – that has been thrown at these spreads as well as the rate cuts we’ve seen, it’s still disturbing to me.  “Convexity kills” to paraphrase Al Davis’ well-worn expression “speed kills” in pro football.

But in the same post, Professor Taylor also gives us a possible reason why we haven’t seen more borrowing:

I have argued since the start of the crisis that the Fed should provide daily (not just weekly) balance sheet data so people outside the Fed can evaluate the impacts of its programs on the markets, but this is all we have. It is not clear why the loans have declined so rapidly. Perhaps criticism about participating in the European bailout led the Fed to discourage the use of the swap loans under the program at a time when the Fed is trying to prevent the Congress from reducing its independence. Or perhaps the interest rate (1.24 percent) was simply too high.

*Gulp!!* 124bps is too much to pay?  That speaks to a very weak banking sector.  Here’s a screen shot from the ECB of the operation:

Turns out, dollar funding has gotten a lot more expensive. 123 bps for a week. Last week, it was 124bps for 3mth dollar swaps.  Either pawnbrokers have overrun the ECB, or more likely, the desperation in European funding markets is just getting more desperate.  Bigger swaps, higher rates and shorter maturities.  That’s not a funding market that is stable.

So in the meantime, dollar Libor rises:

Which, presents another problem:

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.

Make no mistake: traders playing a curve steepener strategy would be slaughtered like enemies of the Corleone crime family.  So may I suggest another bear flattener?  Start selling 2yr Treasury futures and taking down 10yr futures.  Or, if you want to use an option strategy, buy 2yr puts & sell 10yr puts to give you some more flexibility.  The CME Group has done a good job of outlining this in a strategy paper.  I embedded it here:

So the bottom line is this: the quantity of money out there isn’t enough to subdue funding costs/risks.  More is needed, but we’re unsure how much.  So in the meantime, spreads between dollar Libor & 2yr rates need to be watched because we might see “The Mother of All Bear Flatteners” hit the market.

All against a backdrop where adding more liquidity probably won’t help…

Are we having fun yet?

Don’t think any monetarists are at the moment…


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Breaking out the Ginsu 2000 on the LIBOR Curves

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.


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