From Bloomberg, the Libor-OIS spread:
The tiny move down over the past few days is in spite of an absolutely unprecedented splurge from the world’s central banks.
Alea picks up the latest numbers from the Fed:
TAF: $263 bn
Swaps: $450 bn
Balance sheet: $1805 bn up 16% from last week
The extended discount window increase is relatively small, the biggest mover was swaps and TAF accounting for almost all the balance sheet increase.
Literally trillions is being provided in liquidity and the Libor-OIS spread has moved a measly 26.17 basis points. On the basis of central bank interest rate cuts alone, the rate should be coming down sharply, but its not.
From a Bloomberg article, here’s David Keeble of Calyon:
Government participation in the banks along with the huge liquidity operation is flooding the financial system, which is having the desired effect on Libor.
Enter, Felix Salmon:
Er, no: “the desired effect on Libor” is not a 9bp drop from 4.64% to 4.55%. The desired effect on Libor is to get it down to below 2% — something which would normally be entirely reasonable when the Fed funds rate is 1.5%.
So the question is, are the central banks’ liquidity ops working?
Alea also has the latest numbers for Treasury fails: that is, the number of T-bills lent in repo auctions which failed to be returned on time. The figure is the same as it was last week: $2.5 trillion fails to recieve.
If Libor could be said to capture the effectiveness of interbank lending, the number of T-bill failures is a pretty good capture of the effectiveness of liquidity ops from the Fed. The more failures there are, the more all that liquidity is just freezing up when it enters the market. For example:
Fed repos Tbills to prime broker > Prime broker repos Tbills to bank > Bank hoards Tbill > Bank does not return Tbills on time to prime broker > Prime broker has to source Tbills elsewhere to return to Fed > Prime broker more reluctant to repo Tbills in future > Prime broker bids for fewer Tbills in next repo auction.
It is, in fact, a bit of a catch-22. Currently, thanks to a huge flight to quality, most Treasury notes are trading with near-zero yield. Which means, if you’re borrowing T-bills, you have every incentive to hold on to them. It’s cheaper to do so than it is to honour your obligation and swap them back for cash: the Treasury bond has increased in value.
What, though, is the consequence of Libor remaining elevated?
Nick Gogarty (HT Felix Salmon) does some very back-of-the-envelope (but very good) calculations:
The impacts of LIBOR movements are a function of the time of the stress and duration of the contracts and resets. I won’t pretend to have any idea what the average LIBOR denominated debt reset is, but here is a crude tool to estimate the damage so far.
I have calculated the value of a basis point per day of an “elevated” LIBOR.
From which is derived, an estimate of $730bn in “damages” caused by the current elevated rate, above its historical average. “Damage” is, of course, a rather pejorative term. Considering the huge overlap between Libor-linked instruments, and what with the fact that rise will nominally benefit “lenders”, perhaps “stress” is more appropriate. The point still stands.
Whatever color you want to call it, this Swan is getting costlier by the day.
If the TED spread declines at the same rate it went above a “normal” spread of roughly 20-30 bps, assuming the excess is credit damage, then the total LIBOR damage will be in excess of $1.5 trillion.
Here’s hoping Libor falls quickly.
For what it’s worth, some analysts still think it will. RBS wrote in a note yesterday that they expect it to come “crashing down”.
