Bank Stress Rewinds to October After Policy Move: Credit Markets
The global effort by central banks to make it cheaper for financial companies to borrow in dollars to ease Europe’s sovereign-debt crisis may prove little more than a “Band-Aid.”
While the amount European banks pay to borrow in dollars in the swaps market dropped from a three-year high after six central banks led by the Federal Reserve cut overnight borrowing costs, the rate is still near the highest level since 2008. The U.S. two-year interest-rate swap spread, a measure of stress that fell by the most in nine months, remains above where it was in October.
Even as central banks seek to avert a credit seizure like the one that followed the failure of Lehman Brothers Holdings Inc. three years ago, they didn’t address the threat of contagion from bulging budget deficits. Euro-area finance ministers want the International Monetary Fund to take a larger role after saying their efforts to expand the European Financial Stability Facility missed the target.
“It’s more of a Band-Aid,” said Colin Robertson, who oversees $375 billion as Northern Trust Corp.’s managing director of fixed income in Chicago. “The market is ahead of itself in believing this is the end of what’s a pretty significant liquidity crisis and the pressure that’s been building in the banking system and the euro-zone countries.”
The three-month cross-currency basis swap shrank to 118 basis points below the euro interbank offered rate, which reduced the premium traders are paying for dollars paring from a three-year high on Nov. 29 only to the level last seen on Nov. 14. The U.S. two-year interest-rate swap spread slid 10.9 basis points on Nov. 30 to 41.55 basis points. That’s above the level on Nov. 8, and is up from this year’s low of 13.06 on April 28. It fell 0.9 basis points today to 40.7.
“You get these sorts of rallies because, ‘Oh good, nothing bad is going to happen tomorrow,’ because no one’s going to run out of liquidity tomorrow or next week or next month,” Jim Vogel, interest-rate strategist at FTN Financial in Memphis, Tennessee, said in a telephone interview. “But then it dawns on everybody that there are bigger issues that can’t be papered over with official government sources of liquidity.”
Elsewhere in credit markets, the extra yield investors demand to own company bonds worldwide instead of similar- maturity government debt rose 1 basis point to 277 basis points, or 2.77 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 4.245 percent.
Default Swaps Fall
A benchmark gauge of U.S. credit risk dropped for a fourth day. The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, decreased by 1.3 basis points to a mid-price of 126.5 basis points as of 11:10 a.m. in New York, the lowest level since Nov. 8, according to Markit Group Ltd.
The index, which typically falls as investor confidence improves and rises as it deteriorates, has declined from 146 basis points on Nov. 25, which was the highest since Oct. 4. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Six Central Banks
The central banks led by the Fed agreed to lower the premium paid to borrow overnight in dollars by half a percentage point to 50 basis points, the Fed said yesterday in a statement in Washington.
The banks, which included the European Central Bank, the Bank of Canada, Bank of England, Bank of Japan and Swiss National Bank, also agreed to create temporary bilateral swap programs so funding can be provided in any of the currencies “should market conditions so warrant.” Those swap lines were also authorized through Feb. 1, 2013.
While the move improves near-term sentiment, “it’s not in itself the bazooka the market ultimately needs,” Kenneth Silliman, head of U.S. short-term rates trading at Toronto Dominion Bank’s TD Securities unit in New York, said in a telephone interview.
Euro-area finance ministers backed off from the level of firepower that their bailout fund would have and will seek a greater role for the IMF, Luxembourg’s Jean-Claude Juncker told reporters Nov. 29 in Brussels.
The London interbank offered rate increased yesterday before the announcement to 0.529 percent, the highest level since July 2010. The borrowing benchmark fell today to 0.527 percent, the second decline since June. The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, was 42.4 basis points, from 42.3 basis points.
“We’ve been on this road multiple times before,” said Thomas Chow, a senior money manager who helps invest $129 billion of fixed-income assets at Philadelphia-based Delaware Investments. “It’s hard to believe this one step is the one that’s going to cure everything. I do believe it’s a step in the right direction.”
The spot Euribor-OIS spread was little changed at 99 basis points, the most since March 2009. Euribor is the rate at which European banks say they see each other lending.
“The market for their short-term funding remains challenging, especially when we talk about European banks funding themselves in U.S. money markets,” said Jonathan Perez, an analyst who tracks the banking industry at Principal Global Investors, which has more than $200 billion of assets under management. “Many money-market accounts have been pulling back because of concerns over there.”
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