Rising Three-Month Spreads Suggest Worries About Banks Increasing

Posted on by

Just when the Fed thought it had gotten financial markets turbulence under control, conditions start to worsen. Lehman is looking wobbly and markers are signaling increased worries about interbank funding.

Bloomberg tells us that a key indicator of bank willingness to lend, the spread between three month Libor and the forward overnight index swap, is rising, which means the outlook is negative.

From Bloomberg:

Interest-rate derivatives traders are betting banks’ difficulties obtaining cash to fund holdings and shore up balance sheets will worsen.

The difference, or spread, between the three-month dollar London interbank offered rate, or Libor, and the overnight index swap rate, traded forward three months, is greater than similar spreads expiring this month…

“The movement in the forward Libor-OIS spreads is telling you that the market is concerned that things can get even worse before they get better,” said Carl Lantz, an interest-rate strategist in New York at Credit Suisse. “Until all banks’ balance sheets are cleaned up and they’ve re-capitalized, there is going to be funding pressure.”…

The three-month Libor-OIS spread traded forward to June 16, the date the June Eurodollar futures contract expires, was 67 basis points yesterday, while the forward spread corresponding to the September Eurodollar expiration was 72 basis points…

The so-called Libor-OIS spread indirectly measures the availability of funds in the money market. Forwards give expectations for the future.

Overnight indexed swaps are over-the-counter traded derivatives in which one party agrees to pay a fixed rate in exchange for the average of a floating central-bank rate over the life of the swap. For U.S. dollar swaps, the floating rate is the daily effective federal funds rate.

The market has grown more pessimistic since April 30, when the September spread was 6 basis points less than June, according to Credit Suisse….

The spot three-month dollar Libor-OIS spread was 68 basis points today, after ranging from 24 basis points to 90 basis points this year and peaking last year at 106 basis points in December. The spread averaged 11 basis points for the 10 years prior to August, when the global credit crunch began….

The close alignment of three-month Libor-OIS forward spreads through December indicate Libor’s woes will be longer lasting, according Mustafa Chowdhury, head of U.S. interest-rate research in New York at Deutsche Bank AG.

“Instead of being an immediate bank-liquidity problem, Libor is now being affected by a longer-term capital problem,” Chowdhury said. The market “had previously expected the liquidity problems that had boosted the Libor-OIS spread to dissipate relatively quickly.”

Print Friendly, PDF & Email


  1. Anonymous


    The Big Picture had an interesting post (http://bigpicture.typepad.com/comments/2008/06/fasb-bombshell.html) this morning on QSPEs & their ultimate demise under FAS 140. How do you anticipate markets will react this development becomes effective.

    The implications of the change could certainly be material for firms that have utilized such vehicles to varying degrees & for less than transparent reasons (such as goldman & others who have thus far ‘managed’ effectively).

  2. Anonymous

    Try this spread:

    The cost of protecting Lehman Brother’s debt with credit default swaps widened early Wednesday. Lehman’s five-year credit default swaps widened by about 17 basis points to 275 basis points, or $275,000 a year for five years to protect $10 billion of debt, according to data from Phoenix Partners Group.

    I need to cross check this against Bear Stearns!

  3. Anonymous

    Ok, just as a reference and sorry to be OT, but:

    credit default swaps Mar 13, 2008

    The cost of protecting Bear Stearns'(BSC.N: Quote, Profile, Research) debt with credit default swaps surged by 120 basis points on Thursday amid ongoing concerns about liquidity issues at the investment bank.

    Bear Stearns’ credit default swaps rose to 700 basis points, or $700,000 a year for five years to protect $10 million of debt, up from 580 basis points at Wednesday’s close, according to data from Phoenix Partners Group. Bear Stearns has denied talk that it faces a cash crunch.

  4. S

    LEH is akin to trench warfare between the Fed and the market. The Fed has decided that it is going to protect this company at all costs, which means comparisons to Bear seem a strech. Talk in terms of price not livelihood.

  5. Anonymous

    OT: Does anyone know how to find historical info on OTC derivative swaps, e.g:

    The unweighted daily average of the five-year credit default swaps for the following institutions: Morgan Stanley, Merrill Lynch, Goldman Sachs, Lehman Brothers, JPMorgan, Deutsche Bank, Bank of America, Citigroup, Barclays, Credit Suisse, UBS, and Bear Stearns. 3 Spread between yields on three-month U.S. dollar LIBOR and on the three-month U.S. dollar overnight index swap…

Comments are closed.