Money market rates rose further on Thursday as US investment banks close their books for the fiscal second quarter this week and rising bond yields reflect expectations of Federal Reserve rate hikes this year.
The renewed volatility comes at time when the reliability of floating rates set daily, known as Libor, have been questioned by some investors amid massive mortgage and credit writedowns by banks.
The British Bankers Association on Friday releases its annual review of the Libor-setting process, undertaken by a committee made up of 13 market practitioners.
Modest changes are expected given the fragile state of interbank lending. The BBA is thought to believe that finding an alternative and transparent benchmark to Libor for floating rate loans, mortgages and the $350,000bn interest rate derivative market is a difficult proposition. The 16 banks polled for dollar Libor settings, of whom three are US based, have their levels publicly posted.
TJ Marta, strategist at RBC Capital Market said “markets are increasingly antsy about potential changes . . . given the large amount of securities tied to Libor and the already-fragile state of the market, policymakers are unlikely to suggest sweeping changes.”
On Thursday, overnight dollar Libor rose 16 basis points to 2.59 per cent, its highest level for a month. The rate jumped 26bp to 2.43 per cent on Wednesday. One-month dollar Libor rose 7.8bp to 2.46 per cent on Thursday, while three-month Libor at 2.68 per cent remains well above the present Fed funds rate of 2 per cent.
The one-month euro interbank offered rate, or Euribor, climbed 10 basis points to 4.47 per cent, the highest level since late December. In the UK, lenders have been pushing up mortgage rates in recent weeks to reflect the higher cost of funding mortgages through Libor.
Since August, spikes in borrowing rates have characterised the ending of bank fiscal quarters. Goldman Sachs. Lehman Brothers and Morgan Stanley end their fiscal years in November and the last week of May marks the completion of their second quarter.
“With quarter-end for three large dealers coming [today] lenders seem to be a little more aggressive in seeing what borrowers are willing to pay,” said Michael Cloherty, strategist at Banc of America Securities. He also said with market interest rates rising, “money market funds have seemed to be buying more three-month paper, which means they have been pulling cash out of their overnight bucket”.
Expectations of a Fed rate hike in October have intensified this month. The policy-sensitive two-year Treasury note yield has risen from 1.60 per cent in April and was 2.75 per cent on Thursday, its highest level since early January when the funds rate was 4.25 per cent.
Libor is a benchmark reference rate for various currencies provided by banks. They are asked daily by the BBA to “contribute the rate at which it could borrow funds from other banks for certain short-term periods were it to do so by asking for and then accepting interbank offers in reasonable market size”.
However a number of the 16 banks which contribute dollar Libor quotes do not regularly borrow three-month funds from each other. Libor is thus an abstract rate for the broad market.
In the current period of acute lending stress, Libor has been much higher than normal versus the Fed’s overnight borrowing rate. Prior to last August, three-month Libor was regularly set at 11bp over the Fed funds rate. The recent elevation in Libor, however has lagged other market based measures of funding used by the vast majority of financial institutions.
Critics of the Libor process argue banks have misstated Libor and they have not posted higher levels for fear that could arouse suspicion they are encountering difficulty in borrowing funds. Dollar Libor is also set in London before New York opens for business, where the bulk of dollar lending actually occurs.
While the BBA is unlikely to unveil significant changes to Libor, Eric Liverance, strategist at UBS said: “Solutions include making the settings more inclusive, or set when New York is open, or based on actual trades.”
By Michael Mackenzie in New York |
