Posts Tagged ‘TED Spread’

Why Central Bank Swaps Haven’t Put a Stop to LIBOR’s Climb

May 17th, 2010 Michael McDonough Comments off

Defying most investors’ expectations, LIBOR’s climb has continued unabated, despite the reopening of the Fed’s Reciprocal Currency Swap lines.    According to the ECB’s records on May 11th seven bidders tapped USD9.2bn of the swaps at a rate of 1.22%, or nearly 100bps above the OIS funding rate.  Ray Stone of Stone & McCarthy Research Associates, may have the best explanation I have been able to find as to why LIBOR has been unaffected by the Fed’s announcement.  In short Ray says that the liquidity provided by the central banks will be available at ‘fixed rates’ that is set ‘roundly 100bps over the OIS funds rate, or equivalent, setting up a penalty rate similar to the Fed’s discount rate.  Ray believes this penalty rate will act as a ceiling on LIBOR, which according to my calculations would presently put a 1.22% cap on 3M LIBOR, compared to a current rate of 0.460%.  Therefore, the mechanisms significant penalty over traditional interbank funding (LIBOR) ‘accounts for lack of impact on underlying money market conditions’.

3M LIBOR vs 3M Treasury

Source: Bloomberg

Categories: Fed News, US Tags: , , ,

Rising TED Spread Says ‘Hold on There’ to EU Bailout

May 11th, 2010 Michael McDonough Comments off

A slipping Euro isn’t the only indicator hinting that Europe’s unprecedented bailout may be insufficient to ease market fears over the developing debt crisis.  3M LIBOR (the intra-bank borrowing rate for USDs) has again begun to tick upward, albeit modestly; halting a retrenchment in the 3M TED spread.  The spread has average 18.8bps over the course of the year, but currently stands at 28.6bps (see chart), well off the year’s low of 10bps.  This could indicate deteriorating credit conditions as confidence within the banking sector diminishes; the TED spread reached a high of around 460bps after the fall of Lehman.  While the market is still far from these levels, movements in the TED Spread and LIBOR should be monitored due implications on future credit conditions and the fact the rate is used to price a number of derivatives and adjustable rate mortgages.  Yet, over the short-term the reopening of the Fed’s swap lines with other central banks around the world could help alleviate this problem as fresh USDs are poured into these markets that the central banks can in turn lend to other banks within their jurisdictions, increasing liquidity.  

Source: Bloomberg

Categories: Europe Tags: , ,

TED Spread Begins to Spike: Counterparty Risk Rises

May 7th, 2010 Michael McDonough Comments off

Fear is beginning to seep into the European financial system with LIBOR rates edging up; leading to a sharp rise in the three month TED Spread (tracking 3M LIBOR against 3M US Treasuries). While nowhere near its crisis high of over 450bps, the TED Spread has enlarged to 32bps from just 19bps on May 3rd. It is now blatantly apparent, following downgrades of both Portugal and Spain and global asset sell-offs, that the crisis in the Hellenic Republic is not just a domestic or regional issue, but a global one. While the current jump pales in comparison to the spike seen during the collapse of Lehman in 2008, the TED Spread has reached levels not seen since the middle of 2009—while it was still coming off the spike caused by Lehman.

Today’s employment news from the U.S. may help to alleviate some pressure on the markets, but job gains in the U.S. will likely moderate as the year progresses as the economic recovery becomes more tepid. Additionally, we have hardly seen the end of the situation in Europe, with Portugal, Spain, and Italy next on the chopping block if the situation worsens. Yesterday, Spain’s 5Y note auction received the highest yield for the country since 2008, showing liquidity may be drying up for the nation. The situation is worse in Portugal where the country’s yield curve has begun to mirror that of Greece’s leading up to the onset of its domestic crisis.

As the chart below illustrates, for the first time this year, the TED Spread has begun to trade in correlation with the VIX, indicating fear has spread from the equities market into the intra-bank lending market, which could have significant repercussions.

Source: Bloomberg

Categories: Europe, US Tags: , , ,

Lehman’s Impact on the BDI & Shipping (Then & Now)

September 14th, 2009 Michael McDonough Comments off

In retrospect, the widespread panic that engulfed the world’s financial markets after the fall of Lehman Brothers may have been somewhat overblown considering the actual long-term impact of the event, which was significantly mitigated through innovative monetary policy.  But at the time, this did not prevent an almost immediate shut-down of credit markets around the world affecting most, if not all, facets of the global economy.    The shipping sector was no exception.  Within shipping there is an essential financial instrument called a ‘Letter of Credit’ (LOC).   LOCs facilitate the bulk of global trade by guaranteeing the buyer’s funds will be delivered to the seller upon delivery of the goods.  These instruments are issued mostly by financial institutions.

As I mentioned, Lehman’s demise led to an immediate lockup in global credit markets, including LOCs.  To help quantify this I created the chart below, which plots the TED spread against the BDI from 2006. For this application I slightly modified the traditional TED spread and used 3M LIBOR Basis Swap against the Fed Funds rate; this measure acts as a yard stick on implied counterparty risk as LIBOR is the rate at which banks are willing to lend to each other.  You will notice that the unprecedented jump in the TED spread coincides with an extraordinary drop in the BDI from a peak of nearly 12,000 to a low of 663 in only a matter of months.  To help put this into perspective, an article by “The Independent” noted that in June 2008 a shipment of coal from Brazil to China would have totaled US$15mn per voyage compared to US$1.5mn by October, and rates moved even lower from there.

Source: Bloomberg & Capital Link

Source: Bloomberg & Capital Link

Without LOCs, the shipping sector came to what was essentially a standstill. Even where demand still existed, buyers were unable to get the credit to guarantee payments.  A quote from an article in the Financial Post published in October of last year put it best, “There’s all kinds of stuff stacked up on docks right now that can’t be shipped because people can’t get letters of credit,” said Bill Gary, president of Commodity Information Systems in Oklahoma City. “The problem is not demand, and it’s not supply because we have plenty of supply. It’s finding anyone who can come up with the credit to buy.”

How times have changed.  In the year since Lehman’s collapse, credit conditions have improved considerably, as demonstrated by the TED spread, which has begun reverting back toward its historical average.  Better credit conditions have provided increased liquidity allowing buyers around the globe easier access to LOCs.  This alone however does not mean smooth sailing for the shipping sector, but what it does mean is that the sector is highly unlikely to re-test the lows experienced during the end of 2008 and early 2009.