Why It Matters That the FRA-OIS Spread Is Widening

With the 2008 global financial crisis still in the rear-view mirror, the coronavirus and a plunge in oil prices have put jittery markets on the alert for signs of another credit crunch. That helps to explain why one important indicator of stress in the U.S. banking system -- the FRA-OIS spread -- is drawing attention. The spread has spiked to its widest level in more than eight years, even if it’s way off the highs of 2008 and 2009.

Right now it boils down to deteriorating market sentiment about credit and recession risks rather than a genuine fear of a pullback in funding markets. The widening of the FRA-OIS spread -- seen by many as a proxy for risks in the banking sector -- reflects concern that companies will struggle as the new coronavirus exacts its toll on the economy. That makes interbank lending more risky, since banks stand to suffer losses if companies fail. The perceived added risk means banks will demand higher interest payments to lend to one another -- hence the increase in the spread. The forward rate is also a gauge of market expectations for additional Federal Reserve interest rate actions.