Libor Surge Set to Keep Fed on Hold, Deutsche Bank’s Slok Says

  • Exodus from prime money-market funds lifts bank lending rates
  • Move in short-term rates tightens financial conditions

A rise in short-term bank borrowing costs may discourage Federal Reserve officials from tightening policy when they meet this week to debate the path of U.S. interest rates.

Banks’ unsecured lending rates, such as the dollar London interbank offered rate, have soared as a flight from prime money-market funds ahead of new regulations means there’s less cash flowing into commercial paper and certificates of deposit. Three-month Libor has surged to about 0.86 percent, the highest since 2009, from 0.62 percent in late June, according to ICE Benchmark Administration data.

“If the Fed is thinking about raising rates to cool down the economy, well, the fact is it’s already happened,” Torsten Slok, the international economist for Deutsche Bank AG in New York, said in a telephone interview. “It confirms it’s not a good idea to hike rates.”

Short-term rates like Libor have an impact on the financial conditions that the Fed monitors through monetary policy. Higher rates represent tighter conditions, because they increase the burden on companies raising funds and consumers seeking loans for homes or other purchases. Market measures reflect the recent tightening, with the Bloomberg U.S. Financial Conditions index falling below zero, an indication of stress, and declining further this month. 

The benchmark Treasury 10-year note yield rose two basis points, or 0.02 percentage point, to 1.71 percent as of 5 p.m. in New York, based Bloomberg Bond Trader data. The price of the 1.5 percent security due in August 2026 was 98 2/32.

Libor has risen as hundreds of billions of dollars have been exiting the prime funds that will soon face heavier regulation amid a seismic overhaul of the $2.6 trillion money-market industry that will take effect Oct. 14.

Libor’s recent move “is an important argument for the Fed to stay on hold this week,” Slok wrote in a research note Monday. Officials should then “wait and see if short Libor rates remain at these levels after the new money market funds rules go into effect on Oct. 14, or if they begin to come down.” Slok expects the Fed to raise rates in December.

Even after the money-market reform deadline passes, related pressures will likely continue to affect lending rates, Pacific Investment Management Co.’s head of short-term portfolio management, Jerome Schneider, wrote in an Aug. 31 note.

It will take “months, if not several quarters” for Libor to recalibrate lower relative to perceived risk-free rates, Schneider wrote.

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