Despite the cheery tone in the press of late and the claims by quite a few senior banking executives that the credit crisis is on the mend, the money markets remain unconvinced.
As we pointed out in a post yesterday, the results of the Fed’s latest Term Auction Facility auction were disappointing, leading the writer, David Kotok of Cumberland Advisors, to predict that the Fed will not only cut rates a further 25 basis points, but also increase the size of the TAF yet again.
Today, a Bloomberg story discusses the poor results of the TAF auction, and points up two other signs it depicts as troubling. The Libor-overnight index swap spread has increased dramatically since January, although it is still below its early December high just before the Fed announced the creation of the term auction facility. Open interest in Eurodollar swap futures has also fallen, which is an indicator of deleveraging.
Interest-rate derivatives are signaling that the rate banks charge for loans in dollars in London may rise further as financial institutions remain reluctant to lend.
The difference between the rate of three-month loans in London relative to the overnight index swap rate, known as the Libor-OIS spread, is 88 basis points, just below the year high of 90 basis points reached on April 21.
The London interbank offered rate, or Libor, for dollar climbed to a seven-week high amid speculation the global credit crunch prompted lenders to manipulate the rate to prevent their borrowing costs from escalating. The British Bankers’ Association said last week it will speed up a review of the process by which money-market rates are set daily and ban any member providing misleading quotes.
“The correction in Libor has not completely happened,” said Bulent Baygun, head of interest-rate strategy in New York at BNP Paribas Securities Corp., a unit of France’s largest bank. “Given the dynamics that have persisted in the past few weeks, it looks like there could be a little bit more room for an increase.”
Three-month Libor for dollars has advanced 20 basis points to 2.92 percent since April 16.
The three-month Libor-OIS spread was as narrow as 24 basis points on Jan. 24 and reached as high as 106 basis points on Dec. 4. A basis point is 0.01 of a percentage point. The OIS rate signals what traders’ expect the overnight federal funds rate to average over the time period of the swap….
Use of Eurodollar futures, which are based on predictions for Libor rates, as a bet on expected changes in Fed interest- rate policy has waned amid the questions regarding Libor rates, according to Credit Suisse Securities USA LLC, one of the 20 primary dealers that trade directly with the Fed.
Eurodollar futures open interest, or the total number of futures contracts that have not been closed, liquidated, or delivered, declined by 21 percent since the end of January, according to CME Group data. It fell 4.7 percent for the week ended April 18, after the BBA announced it was monitoring banks involved in the Libor process, from the end of the prior week.
“Libor uncertainty has led to a large-scale deleveraging in the Eurodollar complex,” wrote Dominic Konstam, head of interest-rate strategy at Credit Suisse, in a note published on April 18. “Over the past week, the decline in open interest has been dramatic as the problems with Libor have become more publicized.”
Eurodollar futures, which trade in price terms, settle to three-month dollar Libor at expiration.