The London interbank offered rate, known by the acronym Libor, is back on investors radar.
Libor reflects what banks charge to borrow dollars from each other and is used as a benchmark for trillions of dollars worth of loans. The rise is nothing like the panic mode of 2008, when soaring Libor reflected a reluctance by banks to lend to each other, reflecting stress in the system and fueled fears of an existential threat to the global banking system.
But the increase is seen tightening financial conditions. Also on the radar is the sharp widening of the spread between Libor and the overnight index swap rate as three-month Libor moved above 2% for the first time since 2008.
What this means is that rates on more than $350 trillion of debt and derivatives contracts hitched to the U.S. benchmark are on the rise, said David Rosenberg, chief economist and strategist at Gluskin Sheff, in a Monday note.
Overleveraged entities will be in for a spot of trouble. We have a situation where half of the investment-grade bond market in the USA is BBB, he wrote. BBB is the second-lowest investment grade rating by S&P Global Ratings and Fitch Ratings.
In 2016, Libor rose in response to money-market reforms.
The catalyst for the more recent rise, and widening of the Libor-OIS spread, is placed by economists and analysts partly on the U.S. tax legislation signed into law in December. The repatriation of cash held overseas has led to U.S. firms pulling money out of foreign dollar funds, analysts said.
In addition to the suspected return of overseas cash, the financial system is also adjusting to a world of less Federal Reserve-provided liquidity as the central bank unwinds its balance sheet, wrote George Goncalves, head of fixed-income strategy at Nomura, in a late February note.
Meanwhile, analysts will be watching the Libor-OIS spread with the idea that a stubborn wideningand the resulting tightening of financial conditionscould affect the pace of Federal Reserve tightening in the year ahead. Rising Libor in 2016 served to tighten financial conditions, analysts said.
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