Tag Archives: interest rates

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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On Inflation and Bonds… in < 140 Characters

Today I saw an interesting tweet from Jennifer Ablan:

And based on a daily move like this…

you get the impression there’s a divergence.  Stocks have a gangbuster move to the upside while bond yields have been moving lower.  Is Goldilocks appearing again?  Hardly.

But I had a response for her:

Yes, I cited Japan as the example.  But I don’t think they’re going to be alone.  Indeed, there are a couple of ways to look at inflation.  One is just prices paid and you can use the Consumer Price Index or the Personal Consumption Expenditure index.  Well, by either measure, they’re headed lower:

PCE hasn’t fallen the way CPI has but they are both still going lower.  Why?  Because as Steve Keen demonstrated with his Minsky-based approach, aggregate demand is falling because private debt is collapsing and unemployment is rising:

And the 2/10 spread has responded in kind:

One point I’d make is that when you step back and see what’s going on in bonds, unemployment, inflation and debt is there could be a new feedback loop between these things that has taken root.  I don’t know the mechanics of it, but I’d say there’s a link between these phenomena going on.

And it isn’t pretty.  Just ask the Japanese how well things turned out for them the last 20 years…

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Eurozone Banks Are in the Vise

Looking at the Libor rates day after day – and watching them rise without mercy – is starting to get well, painful.  This is a weekly view of euro Libor:

This is a classic bear steepening in the curve: short-dated rates have risen, but the long-dated rates have risen faster.  And it’s shifting out the whole curve by basis points at a time.  In fact, 3mth and 1yr euro Libor rates have been rising on the order of a basis point per day.  But you have to remember Libor rate calculations trim the data: the 4 highest and 4 lowest are thrown out, leaving the middle 8 to determine rates.  So you know there are 4 other banks that are doing much worse than the middle 8.  And since the panel is made up of sizable banks,

Meanwhile, EURUSD has also been on a tear:

I’m going to take a look at correlations between euro Libor and the euro later, because I think there’s something to that story.  In the meantime, we should probably just note that the currency is strengthening as the bear steepener in rates continues.

A strengthening currency and inter-bank interest rates that are rising by a basis point per day?  Sounds like a real-life stress test to me.  So forget about the stress tests the Europeans did.  And if they think the European banks will have the same rebound that the US banks had, maybe they’d better think twice:

“The question is whether governments can shoulder their sovereign debt if they had to bail out half their financial system on top of it,” said Lothar Mentel, chief investment officer at Octopus Investments Ltd. in London “That is the real worry.”

via European Banks’ Hidden Losses Threaten EU Stress Test – BusinessWeek.

Indeed.  A number of those countries are in worse fiscal shape than we are, with economies that are less dynamic and have poorer growth prospects.  I don’t see how their policies are supposed to inspire confidence.

I think it’s just a matter of time before we see “Bank Fail Friday – Euro edition” unless we get something more than just a bunch of concocted stress tests (again from the Bloomberg Businessweek article):

“You can’t just have stress tests, you’d better prescribe some medicine as well, which is going be more capital-raising,” said Hank Calenti, a credit analyst at Royal Bank of Canada in London. “If some institutions need access to government recapitalization or other improvements, the market needs to know how that’s going to happen.”

Meanwhile, the cost of capital is going up…

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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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A 6.30 Earthquake in Libor

Well that didn’t take long.  Yesterday I was speculating rates would go up, and here it is:

You can see my note on the chart.  Now let’s take a look at the term structure of spreads between Dollar and Euro Libor:

The curve is flattening, in a big way.  With ECB open market operations results in now, the liquidity picture is, well, unclear.  Folks cheered yesterday’s 3mth LTRO, saying it wasn’t as big as expected, but results of today’s 6 day operation and yesterday’s weekly MRO suggest to me there are definitely a bunch of banks in a world of hurt.  Why else would you borrow money for 6/7 days at 1% when the Libor market allows you to lock up 6mth Euro Libor funding at the same rate?

I think FT Alphaville put it best (emphasis, mine):

And now that we know we’re looking at a two-tiered existence for eurozone banks — those that can fund themselves in the interbank market and those that still have to rely on the ECB — we can guess that a rapid rise in rates could be difficult for some to take. In which case, we could still see rates like Eonia and Libor rise on fears of bank counterparty risk. It’s a tough job, this weaning-off-liquidity thing.

And, some might say, still a highly-improbable outcome.

via FT Alphaville » More please … the 12-month LTRO roll-over ain’t over yet.

In other words, this may be just the beginning.

The ECB is just trying to use methadone on heroin addicts at this point.  We’ll see how this goes…

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