“It is in the nature of people to extrapolate from the recent past. In the recent past, stocks have been a one-way bet. Such is life under a regime of limitless liquidity and zero percent interest rates (or even lower). As for bonds, there is probably not a trader still toiling in a dealing room who has experienced anything other than declining rates during the entire duration of their career. This is not an environment conducive to the future stability of asset prices.”—Tim Price
Global Liquidity Strains Intensify as Surging US Libor Rates Spur Global Financial Market Liquidations!
Last week, sellers pounded the major US equity benchmarks back to their early February lows. The Dow Jones Industrials, the S&P 500, the Nasdaq Composite and the small-cap Russell 2000 hemorrhaged by -5.67%, -5.94%, -6.54% and -4.79%.
Media wires pinned the blame mechanically on Trump’s economic war against China and the Facebook-Cambridge Analytica scandal. For the latter, private data of some 50 million Facebook users were inappropriately shared with a political consultancy group reportedly for election purposes. To spice up on these popular narratives, Jerome Powell’s inaugural move as the US Federal Reserve Chairman was to raise Fed Fund Rates for the sixth time since the Great Recession. The Fed has been projected to hike its policy rates thrice this year.
Surging Libor: US dollar Liquidity Strains Fuel Global Risk OFF
Yet, the establishment paid little attention to what mattered most: US dollar liquidity flows.
From Bloomberg: “From Riyadh to Sydney, short-term funding markets worldwide are starting to feel the effects of soaring U.S. dollar Libor rates. The surge in recent weeks in this key global short-term financing indicator may have a mostly technical explanation, meaning it’s probably not flashing warning signals like it was during the credit crunch or the European sovereign debt crisis. Nonetheless, it’s still making funding more costly for some borrowers outside the U.S. The three-month London interbank funding rate rose to 2.27 percent Wednesday, the highest since 2008. The concern is that the Libor blowout may have more room to run, a prospect that borrowers and policy makers in various markets are just beginning to grapple with.” [bold added]
In March of 2017 or a just year ago, I warned about this: [See Has the Fed “Fallen Behind the Curve”? March 11, 2017]
LIBOR rates have been rising across the curve since 2015: overnight, 1-month, 3-month, 6-month, 12-month. Goldman Sachs estimated that $28 trillion of loans have been tied to Libor. While LIBOR rates are way off the highs 2007, the fact they are rising could be a sign of emergent hidden stress.
Much of these had been blamed on the 2a7 reform, but today they seem as mostly imputed to prospective interest rate actions by the FED.
And yet, despite higher inflation expectations, yield spreads have been flattening. An example would be the 10-2 year spread.
Perhaps such has affected the rate of growth (% from a year ago) of commercial industrial loans, which at 6.7% in January, has tumbled to 2013 lows.
The difference between then and now, current Libor rates have begun to bite!
And instead of improving, things have gone from bad to worse…
As of February, the year-on-year growth rate of Commercial and Industrial loans of All Commercial Banks have grounded to a near standstill at 1.6%! The massive slowdown in bank credit expansion has spilled over onto money supply conditions. As of March 12, US M2 growth has slowed to a measly 3.9%! Both are headed towards recession levels.
There is more. The FED has embarked on normalization of its balance sheet, where it has trimmed some $41 billion (1.7%) of US Treasury holdings from October 25, 2017 to March 21, 2018.
The US dollar liquidity squeeze, which partly has been triggered by the banking system and by the FED’s downsizing of its balance sheet, has been ventilated through Libor rates!
And global “US dollar” liquidity strain have likewise been expressed via the spiking Yen and the plunging Hong Kong dollar (to 1984 lows!) has coincided with the recent risk OFF.
As an aside, to align with the US FOMC’s rate hike, the central bank of Hong Kong (HKMA) raised its base rate while China’s central bank (PBOC) increased its 7-day repo rate.
Philippine T-Bill Rates Spike!
Such liquidity crunch has likewise been evident in the domestic financial markets.
External factors appear to be compounding on internal dynamics. Rising Philippine ROP 3-month and 6-month T-Bill yields have been accelerating.
The setting and publication of Phibor rates, the domestic counterpart of LIBOR, have been suspended by the Bankers Association of the Philippines, effective 15 April 2013, according to the Bangko Sentral ng Pilipinas (BSP).
Despite higher CPI, nascent symptoms of tightening liquidity could be one key reason behind the BSP’s decision to stay policy rates at present historically low levels last week.
The BSP has been trapped from their addiction to free money!
Well, easy money domestic policy in the face of US dollar liquidity strains should translate to a weaker peso. Hence, the USD Php surged by .89% to Php 52.39; a level last reached in 2006.
Both exogenous and endogenous forces will likely power the USD peso to new heights in the coming sessions.
Banks and Financials Bore Libor’s Brunt
The acceleration of global liquidity pressures has hit the global bank and financial stocks most.
Citing Credit Bubble Bulletin’s Doug Noland, “Deutsche Bank (DB) dropped 13% this week to a 15-month low. DB is now down 28% y-t-d. European banks (STOXX) sank 5.0% this week. Hong Kong (Hang Seng) Financials were down 4.9%. Japan's TOPIX Bank index fell 3.3%. In the U.S., banks (BKX) were slammed 8.0%, the "worst loss in two years." The Broker/Dealers (XLF) fell 7.3%.”
Down by 4.14% (-7.94% year to date), the Philippine Stock Exchange’s Bank and Financial index hemorrhaged the most among the 5 mainstream sectors.
Stocks, as I have rightly pointed out last February, would be the last to know. Now all three forces have converged: the peso, bonds and lately stocks have been undergoing selling pressures. [see Bullseye! Panicked BSP Slashed Reserve Requirements in the face of Meltdown in Philippine Bonds! February 18, 2018]
The receiving end of intensifying credit stress will be the stock market.
For now, a sustained rise in Libor rates will likely incite more uncertainty in the credit markets. Yields of Investment Grade (IG) corporate bonds have increased with Libor rates (with a time lag) along with global bank credit risk conditions.
And with the world inundated with trillions of US dollar liabilities, tightening liquidity conditions may spur a short squeeze or vicious rally in the US dollar (lower window).
Protectionism Will Add To Liquidity Strains; If Goods Don’t Cross Borders Armies Will
An escalation of Trump’s economic war would only aggravate the current liquidity predicament.
Much of media labels Trump’s trade barrier a ‘trade war’. But this is misleading. A trade war is self-contradictory. An act of voluntary exchange is not the same as an act of hostility. Trade affirms the sanctity of property rights. War destroys life, seizes properties and therefore, undermines property rights.
Nevertheless, should the US government make good on its threat to impose hefty tariffs, the effects would involve material changes in prices, resource allocation, productivity, production structure, economic output and people’s living standards.
This week, US President Donald Trump targeted China to impose $60 billion of expanded tariffs covering a multitude of goods. In early March, Mr. Trump implemented sharply higher steel and aluminum import tariffs against major trading partners. And pending trade negotiations, several trading partners were temporarily exempted from this protectionist maneuver
On a global scale, aside from upsetting current trade and economic arrangements, it will undermine capital, investments and liquidity flows, as well as, most importantly, geopolitical relationships.
A reduction of global trade will mean less global liquidity.
Importantly, heightened geopolitical tensions translate to the rising prospects of the risk of war.
If goods don’t cross borders armies will. That’s a quote largely attributed to the great classical liberal, proto Austrian economist, Claude Frédéric Bastiat
This axiom should be highly relevant today.
