Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Add this one to the list of market shifts in Asia that have been caused by U.S. regulators trying to fix domestic problems. The recent spike in Libor has started to sound alarm bells among investors in Hong Kong and Singapore, who fear the higher funding costs could impact the region's bond market.

Three-month Libor, a key benchmark for funding costs everywhere, reached the highest since May 2009 on Friday. The move is being blamed on new rules set to take effect Oct. 14 that make government money-market funds in the U.S. more stable, and therefore more attractive. As a result, billions of dollars are shifting out of funds that also invest in short-duration corporate debt, increasing the cost of borrowing for banks and driving up Libor.

Costly Funding
The world's most widely used benchmark for dollar financing has hit the highest since May 2009
Source: Bloomberg

In Asia, half a world away from Washington, those rules have the potential to reverse a rally in high-yield bonds. The premium that dollar-denominated junk debt from Asia pays over U.S. Treasuries is at the lowest since 2007, as measured by a Bank of America Merrill Lynch index.

End of Summer
The extra spread investors demand to hold Asian junk dollar bonds fell to 492 basis points on Friday, the least since 2007
Source: Bank of America Merrill Lynch indexes; Bloomberg

Reasons for that good performance range from negative interest rates in Japan and Europe to a more active Chinese domestic bond market that's keeping some of the riskiest issuers away from dollar debt. But another big driver has been private banking clients.

Wealthy individuals in Asia have indulged a love affair with junk debt since 2011, often with the help of margin loans that allow them to purchase even more securities and supercharge returns. However, higher funding costs for banks means their clients are about to see costs go up too, which could trigger a sell-off in bonds bought on margin.

Banks themselves are also significant buyers of investment-grade notes in the region. As funding costs rise, treasuries could reduce their holdings as well, especially of debt that sits on the lower rungs of investment grade.

Already, gains from buying corporate bonds with money raised elsewhere are being squeezed. Average coupons on certificates of deposits from banks in Asia hit the highest in at least two years in June and haven't retreated much since.

Imminent Squeeze
The average yield paid by banks in Asia to borrow short term has spiked this year
Source: Bloomberg

The effect is yet to fully play out, but hawkish remarks by Fed officials last week only add to the pressure on benchmark dollar rates like Libor, which suggests that for now, the only way is up.

As the margin calls start rolling in, expect high-yield bonds in Asia to falter. Investment-grade notes will probably adjust to the new funding reality also. An unintended consequence of the U.S. Securities and Exchange Commission to be sure, but one with potentially serious ramifications.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net