Recently, the Libor-OIS spread has continued to expand, and the ” dollar shortage” has intensified.
On Wednesday, Libor rose again by 0.38% to 2.3246%, setting a new high since November 2008. At the same time, recent consecutive rises also set the longest increase cycle since November 2005. The Libor-OIS spread widened to nearly 60 basis points.
Matt King, a global debt strategist at Citi, points out that the real reason behind the spread widening is related to the overall shortage of funds in the US dollar and tightened financial conditions. The recent sharp decline in the bank’s credit default swaps (CDS) has also confirmed this. King further pointed out that the widening interest rate spread indicates that the Fed is in a predicament, and any further tightening may lead to the spread of the financial crisis and further cause a shortage of US dollars.
The Libor-OIS spread is an important indicator of how easy it is to obtain money in the money market. It mainly reflects the credit pressure of the global banking system. If interest spreads widen, it usually means that the willingness to lend to banks is falling.
King believes that one of the key signs is that the sharp changes in interest rates may not be technical at all, but rather the Federal Reserve’s by-products of tightening currency. The impact of this by-product is more structured and dangerous, which means that the Fed is in a difficult situation. Any further tightening may lead to the spread of the financial crisis and further cause a shortage of the US dollar.
King said in an interview with CNBC:
We can see that the relatively modest evacuation of the central bank has suddenly produced wider consequences than expected, which has indeed caused a larger scale of deflation, just as we have two extra-than-expected Fed rate hikes .
However, the problems we have encountered so far are not systematic. We do not have to worry that the banking system will collapse as it did in 2008 or 2012. However, we also expect that the current pressure will increase. However, as the Fed continues to lose excess reserves, the situation may be even more tense.
King believes that the depletion of the Fed’s excess reserves is the most important long-term driver of the US dollar shortage:
The Fed is running out of reserves and now consumes 30 billion U.S. dollars every month, and then may increase to 40 billion U.S. dollars in the next quarter, and the pressure will steadily increase.
So far, the tax reforms and the resulting changes in corporate finance have brought pressure. But the problem is that this situation will not disappear, and this is a structural change.
King pointed out that when Libor-OIS spreads soared, the cost of debt hedging increased sharply and the cost of foreign investors buying US Treasuries and corporate bonds increased significantly:
Last year, 80% of the net purchases of U.S. corporate bonds came from foreign investors and mutual funds. They have stopped buying in the past few months and the market has always hoped that they will be able to buy as before.
However, if you are a Japanese investor, your cost of hedging will increase from 2.50% to 2.75%, and you know that with each time the Fed raises interest rates, costs will increase. Suddenly, U.S. bonds are less attractive. Under the conditions of low global market sentiment, it is hard to believe that U.S. bond markets will rebound.
On March 20, King warned:
Libor is still the reference benchmark interest rate for most leveraged loans, interest rate swap products, and some mortgages currently on the market. In addition to the direct impact on the aforementioned financial products, the higher money market interest rate (rising from rising Libor) and the weak performance of risk assets all contribute to the outflow of mutual funds.
If the withdrawal of funds from mutual funds further exacerbates the selling of the market, the indirect negative impact of the wealth effect on the economy may even exceed the direct impact of rising market interest rates.