Photographer: Simon Dawson/Bloomberg
markets

It's Getting a Whole Lot Harder to Trade Bank of England Rates

  • GBP basis means more domestic borrowing, wider FRA/OIS: MS
  • New dynamics as positions in Short Sterling futures hit record

The surge in short-term borrowing costs in dollars may be spreading closer to home.

Three-month dollar Libor has jumped to well-above market expectations for Federal Reserve target rates, while sterling cross-currency basis swaps have turned positive against the greenback. This may be prompting commercial paper issuers to switch from dollars into foreign currencies, particularly the pound and Australian dollar, according to Morgan Stanley strategists including Sam Elprince. The new supply may be responsible in part for pushing up banks’ borrowing costs.

The higher cost of borrowing complicates matters for traders of Short Sterling futures and options, which are cash settled against three-month Libor fixings, with the prospect of an interest-rate hike from the Bank of England looming. Additionally, positioning in these futures climbed to records earlier in March, according to a company statement from Intercontinental Exchange, distributed by Business Wire.

Money markets are showing evidence of rising borrowing costs. The Sterling FRA/OIS spread, the difference between three-month Libor, the rate at which banks borrow from one another in pounds, and overnight index swaps, a proxy for the BOE’s official bank rate, has increased four basis points since March 22. The pound-dollar three-month cross-currency basis swap has surged more than 29 basis points in March, settling around the most positive levels on record.

The funding advantage of issuing in U.S. markets has been eroded by moves in cross-currency markets. It is now cheaper for U.K. banks to borrow in pounds and then swap into dollars.

For example, a bank may borrow pounds at the three-month Libor rate of 0.683 percent. If it then swaps the proceeds to dollars, it can pick up 18 basis points from the positive three-month cross-currency basis, leaving it funded at three-month dollar Libor rate of 2.30 percent minus 18 basis points, or 2.12 percent.

— With assistance by Masaki Kondo

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