With the recent rise in LIBOR we have been reading a lot of concerns over what it all means. The two main arguments that we have seen is that either it is due to liquidity concerns or it is due to the supposed recovery in the United States economy. For many reasons we obviously fall on the side of this being led by fear and liquidity rather than due to a recovery and an expectation of the Fed raising rates anytime soon.
The first thing that would lead us to assume that this is due to panic and not recovery is the way in which LIBOR is rising. What we mean is that if you compare it to T-Bills it usually trades very much in line except in times of fear. Looking at the chart below you can see that the last three times that it has diverged was also when we had banking system fears. The top in the summer of 2007 which kind of started off the whole mess, fall of 2008 when the world seemed to be falling apart in front of us, and then in late winter 2009 when we already had the ZIRP in place but it looked like things might be getting even worse. Of course once things got back on track and the end of the world as we know it was at least postponed the relationship got back in line with LIBOR at a slight premium to T-Bills like regular times. Another thing that we find odd is that if LIBOR is rising on a recovery then why aren’t T-Bill or 2-Year Treasury yields climbing? Would bond investors not drive yields higher if they thought this recovery had legs?
3-Month LIBOR and T-Bills
Looking at other money market spreads shows much of the same thing. Namely that spreads are going up, this by the way is usually not a good thing. Looking at the TED spread, LIBOR-OIS spread, and 90-day commercial paper-T-Bill spread you can see that they have all been climbing since the Greece and EU problems really started to gain some attention.
Money Market Spreads
Now lets look at some spreads in other nations. It should come as no surprise that they are also on the rise. In the first chart we have the EURIBOR-OIS spread, after spiking higher it has continued to inch its way basis point by basis point wider and wider.
Next up is the TIBOR-OIS spread. As you can see it is also rising although a lot slower then in the US or in the EU. As we will see in a few charts however that is how it always is.
Finally we have the UK LIBOR-OIS spread. Again it should not be much a surprise that it too has been climbing quite a bit. The UK is weak and its nearest mega-economy the EU is weaker. Banks are and should be scared.
Looking at the three spreads over the last few years you can see in the chart below that the global banking crisis affects them all. Another thing worth noting is that Japans spread (the yellow line) may be rising slower but the swings have been far more muted the whole time. Of course Japan has been dealing with a broken banking system for almost two decades now.
EURIBOR-OIS TIBOR-OIS UK LIBOR-OIS
We will end this post with one last indicator that we follow closely and that is the VIX. This volatility index is simply an average of stock, bond, currency, and commodity volatility indexes. If most asset classes are seeing an increase in volatility it rises and if most are declining it goes down. As you can see in the chart below it has been going up the last few months as many market participants are once again focusing on risks.
In closing we have many concerns in our current situation. Some pundits claim that markets are headed higher and that we are under estimating the recovery. They say that everyone is too worried and that the fundamentals are strong. We apparently are looking through an entirely different lens. With the EU continuing to deteriorate we cant help but wonder how investors can look at the rise in LIBOR as anything but bad. While Greece is indeed a small nation the Euro is what is at stake. Yes, the same Euro which is probably the biggest economic experiment of the last 30+ years. In addition to the EU we have “regular” geo-political concerns as well like Iran, the Korea’s, and our future energy supply. So while we could of course go higher we definitely should be concerned.