Sterling Money Markets Signal Trouble for Banks Closer to Brexit

  • There’ll be ‘more nervousness’ ahead: Commerzbank’s Schnautz
  • FRA/OIS spreads show greater risk after March trigger date

Brzeski: Brexit Noise Clouds Base Case for Banks

Money markets are zeroing in on Article 50 as the catalyst for increased risk in banks’ pound borrowing.

A gauge of where bank borrowing costs will be in coming months, known as the FRA/OIS spread, shows a marked increase in traders’ perception of risk beyond March 2017. That’s the point by which U.K. Prime Minister Theresa May has pledged to formally invoke the article of the Lisbon Treaty that will formally put the nation on a path out of the European Union.

The difference between sterling overnight-indexed swaps and three-month forward-rate agreements expiring in September 2017 has jumped seven basis points this month to the widest since April, while that due in March increased five basis points. The expanding difference between the two expiry dates, known as spread curve steepening, may reflect a greater risk of interbank funding stress in the later period.

The widening has accelerated since May’s speech earlier this month at the Conservative Party conference, which fueled speculation that the U.K. is headed for a separation that places greater priority on controlling immigration rather than ensuring maximum access to the EU single market. One of the main dangers is that U.K.-based banks may lose so-called passporting rights that allow them to sell their services in the world’s biggest trading bloc.

“As we clear year-end, this will then be the time where it’s really worth checking the money-market rates because then you get a clearer picture of what may be going on,” said David Schnautz, a director of fixed-income strategy at Commerzbank AG in London. “It’s not a non-event for the market. I would expect more nervousness for sure” to be reflected in money markets closer to the trigger date, he said.

The FRA/OIS spread is a measure of bank risk, which ballooned during 2008’s financial crisis. While the sterling gauge has climbed steadily since the Brexit vote, its still less than one-eighth of its 2008 peak.

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