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.
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.”