Stress Levels Flash Red in World’s Funding Markets on Brexit Winby
Gauge of bank borrowing costs at most extreme in 4 years
BOE Carney says U.K. banks are able to withstand the turmoil
Stress levels are flashing red in money markets after the U.K. voted to quit the European Union, raising the prospect that policy makers will act to ease market turmoil.
A gauge of where bank borrowing costs will be in coming months, known as the FRA/OIS spread, reached the most extreme level since 2012 as the referendum sapped investor appetite for risk and spurred concern that some European banks will find it harder to fund themselves.
Bank of England Governor Mark Carney said policy makers are ready to pump 250 billion pounds ($345 billion) into the financial system, though he said U.K. banks can withstand the turmoil. The Federal Reserve said it’s prepared to provide dollar liquidity through swap lines with central banks as needed. The pound plunged to its lowest in more than 30 years while demand for shelter drove Treasuries to their biggest surge in seven years.
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“Events in the U.K. have clearly opened a Pandora’s box not just in the U.K. but in Europe as a whole,” said Nick Stamenkovic, a bond strategist at broker RIA Capital Markets Ltd. in Edinburgh. “Still, we are not going to see the same issues with banks that we saw during the 2008-09 financial crisis” because of the liquidity support from global central banks and the restructuring of banks’ balance sheets.
The three-month FRA/OIS spread widened to as much as 0.34 percentage point, compared with 0.27 percentage point on Thursday. The measure indicates where traders expect the gap between the three-month dollar London interbank offered rate, or Libor, and the fed funds effective rate -- a gap dubbed Libor/OIS -- will be in the future. The dollar Libor/OIS spread was about 0.27 percentage point on Friday. The gap reached a record 3.64 percentage points in October 2008, the month after Lehman Brother’s Holdings Inc. went bankrupt.
Overnight index swaps, or OIS, signal traders’ predictions on what the Fed’s effective funds rate will average for the term of the swap. The central bank’s target rate is set in a range of 0.25 percent to 0.5 percent and the effective was 0.38 percent on Thursday. Traders now see just a 12 percent probability that the Fed lifts rates this year, down from 76 percent a month ago.
Institutions including the Fed and the European Central Bank are primed to pump liquidity into the system if needed. The International Monetary Fund supports commitments by the BOE and the ECB to supply liquidity to the banking system and curtail financial volatility, Managing Director Christine Lagarde said in an e-mailed statement.
A key measure of the cost for banks to convert euro cash flows into those in dollars reached the highest since July 2012. Three-month cross-currency basis swaps were 0.46 percentage point below the euro interbank offered rate Friday, from 0.36 percentage point Thursday. At its most extreme Friday, the gap was at 0.69 percentage point.
“There was demand for dollars in the money markets, which reflected funding pressures in the short end, which is usual around these types of events,” said Neil MacKinnon, a London-based strategist at VTB Capital Plc. “Central banks know what to do overall and the Fed ensures its currency swap arrangement are available. This all helps mitigate any systemic risk and diminish any persistent funding pressures.”