Tag Archives: Eurozone

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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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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A Trillion Here, A Trillion There, Pretty Soon You’re Talking About Real Money

What a way to start out the week:

The European Central Bank, the Bank of England and the International Monetary Fund have all recently warned of a looming crunch, especially in Europe, where banks have enough trouble raising money as it is.

Their concern is that banks hungry for refinancing will compete with governments — which also must roll over huge sums — for the bond market’s favor. As a result, credit for business and consumers could become more costly and scarce, with unpleasant consequences for economic growth.

via Crisis Awaits World’s Banks as Trillions Come Due – NYTimes.com.

Wow.  I didn’t know I could get a S**t Sandwich special first thing on a Monday…

And in case that wasn’t enough, they threw in a menacing chart for emphasis:

And just in case you still didn’t get the message, there’s this quote from the article:

“There is a cliff we are racing toward — it’s huge,” said Richard Barwell, an economist at Royal Bank of Scotland and formerly a senior economist at the Bank of England, Britain’s central bank. “No one seems to be talking about it that much.” But, he added, “it’s of first-order importance for lending and output.”

And so this is where I roll out one of those Minsky charts that illustrates this.  Oh, wait:

But why all the fuss over banks being able to roll the debt over?  Forget the amount for a second.  The key is to look at the average maturity:

A study in November by Moody’s Investors Service found that new bond issues by banks during the past five years matured in an average of 4.7 years — the shortest average in 30 years.

Now why does that matter?  It matters because there’s this issue called a maturity mismatch, where the assets and liabilities have different maturities.  Usually the assets are longer dated than the liabilities because when a yield curve is upward-sloping like this (from the FT)…

The incentive is to borrow short-dated funds and lend on long-dated assets.  I’ve covered this in similar ways before talking about duration hedging in the past where you measure sensitivities to interest rate moves, and this follows in a related vein.  When the yield curve inverts, or you have rate shocks at the front-end of the curve, you can find yourself in a precarious position if you have a lot of paper to roll.  Which is exactly where a lot of banks are finding themselves now.

But take a look at this section from the article (emphasis mine):

The financing crunch has its origins in a worldwide trend for banks to borrow money for shorter periods.

The practice of short-term borrowing and long-term lending contributed to the near-collapse of the world financial system in late 2008 when short-term financing dried up. Banks suddenly found themselves starved for cash, and some would have collapsed without central bank support.

Government bank guarantees extended in response to the crisis also inadvertently encouraged short-term lending. The guarantees were typically only for several years, and banks issued bonds to match.

So the maturity mismatch issue played a huge role in getting us into this mess, and the government’s response may very well end up in exacerbating the problem.

Brilliant… I might as well go build a house and then torch it myself…

And Tim Backshall has a very interesting chart that shows the spreads between senior bank debt and sovereign are highly correlated and compressing.  That means the lines between sovereign and bank debt in Europe are getting blurrier:

One other facet about this problem: the link between external bank funding and Euro Libor:

Bond issuance by financial institutions in Europe plunged to $10.7 billion in May, compared with $106 billion in January and $95 billion in May 2009, according to Dealogic, a data provider. New issues have recovered somewhat since, to $42 billion in June and $19 billion so far in July.

My take: proof positive that the funding crisis for European banks is ongoing and getting worse.  How so?  Simple.  Longer dated bond issuance has fallen, which has led to a change in the maturity profiles of European bank liabilities.

Because the banks are rolling into shorter-dated Libor based funding…

Which has lead to the run-up in the Euro…

One way to mitigate this risk is matched maturity funds transfer pricing – where the asset side of the balance sheet has the same maturity profile your liabilities has.  I’m going to leave you with this paper which I also posted on Scribd:

And a link to this post by Don van Deventer at Kamakura, that has some really good ideas on how to implement funds transfer pricing effectively.

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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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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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