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Weekly Economic Commentary

Weekly Economic Commentary

Categories: General, General

Short-term funding markets worldwide are starting to feel the effects of soaring US dollar Libor rates. Libor is the key benchmark interest rate indicator used globally for short term financing (borrowings and investments). The Australian equivalent is BBSW (the bank bill swap rate).

The surge in Libor in recent weeks may have a mostly technical explanation and is not flashing warnings like it did during the credit crunch or the European sovereign debt crisis. Nonetheless, it is still making funding more costly for borrowers around the world, including Australia. The three-month Libor funding rate rose to its highest level since 2008 last week. The concern is that this Libor increase may have more room to run even higher, a prospect that borrowers and policy makers in various markets are just beginning to grapple with.

The current situation can be explained as a sort of “perfect storm” of factors that are tightening financial conditions and forcing Libor higher. The Libor increase is due in part to the flood of US Treasury-bill issuance since the US debt ceiling was raised last February, which has helped drive short term bill rates to their highest in 10 years. Donald Trump’s US tax overhaul is also coming into play by spurring expectations that companies will park cash in short term commercial paper as part of their repatriation of money back to the US to benefit from lower taxes. And of course there’s the fact that the US Federal Reserve is tightening monetary policy at the moment.

Whatever the explanation, the phenomenon is becoming a global one and we are seeing the effect here in Australia.

Local banks, along with their global counterparts, tend to look to the US for a large portion of their funding requirements each year. However, the increase in US Libor rates is making overseas borrowing more expensive. This has forced local banks to do more issuing/borrowing here and has resulted in an increase in Australia’s short term benchmark funding costs, namely BBSW.

Short-term funding costs for Australian banks are set for their biggest monthly increase since 2010 with the spread (difference) between the official cash rate and BBSW having doubled since January. In fact, the three-month BBSW has risen to 2.00% from 1.77% a month ago.

At what point does all this become damaging and how far does it go? That is the issue. We better be prepared for possible higher BBSW as well as wider cash/bills spreads until the RBA starts to raise rates and this is not happening soon..

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Source: Rural Bank

 

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