It’s becoming harder to ignore the spike in the London Interbank Offered Rate.
This key benchmark rate for trillions of dollars of debt has risen to the highest level since 2009, largely because of new money-market rules that go into effect in October. Regardless of the cause or permanence of the rate increase, broader effects can already be seen throughout markets, and the Federal Reserve should take greater notice.
For example, a Bloomberg News article on Thursday highlighted how companies are opting to finance themselves with longer-dated bonds rather than commercial paper borrowings, which are pegged to Libor.
Meanwhile, investors are gravitating toward Libor-pegged debt to earn the higher rate in an otherwise low-yielding world, pouring money into leveraged-loan funds at the fastest pace since April 2014, according to an Aug. 18 report by Wells Fargo strategists led by George Bory.
And foreign banks that rely on this short-term market for dollar-denominated financing have increasingly moved to the swap market instead, pushing up the implied cost of borrowing dollars. This has ended up making U.S. Treasuries less appealing for Japanese investors because of the high currency swap rates.
Given all these distortions, it makes sense that the Fed would care a lot about this, right?
So far, though, policy makers have not indicated it's a particular concern.
In the meeting minutes from the Fed’s July meeting, the policy makers noted somewhat higher risks stemming from "maturity and liquidity transformation," with "the potential for large withdrawals by investors in anticipation of those changes to lead to some disruptions in the short run." They also noted some effects seen in the use of its overnight reverse repurchase agreement facility.
That was it. Not exactly Earth-shattering stuff. The Fed’s comments suggest that it grasps the dynamics behind this rise in rates and that it will have little effect on its longer-term plans.
But the sneaky development may deserve a little closer attention.
After all, the costs of Libor’s increase are being felt broadly across Corporate America and well beyond. Even if the higher rates are insignificant against a backdrop of ultralow rates elsewhere, the Fed needs to carefully consider the ramifications of Libor’s rise because it’s highly relevant to its decision to raise overnight interest rates.
While Fed members may dismiss this issue in the short term, "It will however be a bigger discussion point in December if there is a real discussion about tightening at that time," Triple T Consulting’s Sean Keane wrote in note distributed to Credit Suisse clients on Thursday. "The debate about the real domestic impact of the rising Libor rate should be somewhat easier to settle by then as the Fed will have more data to tell them whether the market has done the tightening for them."
Fair or not, there is a perception that the Fed's credibility has eroded as it struggles to get a handle on the U.S. economy. It would be wise to give markets some sense of how seriously it takes Libor’s rise well before December, starting with Chair Janet Yellen's highly anticipated speech in Jackson Hole, Wyoming, on Friday. It's a surprise the Fed can live without.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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