A number of market-based indicators are signaling that dollar liquidity is tightening. Tread carefully. From Ambrose Evans-Pritchard at telegraph.co.uk:
Surging rates on dollar Libor contracts are rapidly tightening conditions across large parts of the global economy, incubating stress in the credit markets and ultimately threatening overvalued bourses.
Three-month Libor rates – the benchmark cost of short-term borrowing for the international system – have tripled this year to 0.88pc as inflation worries mount.
Fear that the US Federal Reserve may have to raise rates uncomfortably fast is leading to an acute dollar shortage, draining global liquidity.
“The Libor rate is one of few instruments left that still moves freely and is priced by market forces. It is effectively telling us that that the Fed is already two hikes behind the curve,” said Steen Jakobsen from Saxo Bank. “This is highly significant and is our number one concern. Our allocation model is now 100pc in cash. This is a warning signal for the market and it happens extremely rarely,” he said.
Goldman Sachs estimates that up to 30pc of all business loans in the US are priced off Libor contracts, as well as 20pc of mortgages and most student loans. It is the anchor for a host of exotic markets, used as a floor for 90pc of the $900bn pool of the leveraged loan market. It underpins the derivatives nexus. The chain reaction from the Libor spike is global. The Bank for International Settlements warns that the rising cost of borrowing in dollar markets is transmitted almost instantly through the global credit system.
“Changes in the short-term policy rate are promptly reflected in the cost of $5 trillion in US dollar bank loans,” it said. Roughly 60pc of the global economy is linked to the dollar through fixed currency pegs or “dirty floats”, but studies by the BIS suggest that borrowing costs in domestic currencies across Asia, Latin America, the Middle East, and Africa, move in sympathy with dollar costs, regardless of whether the exchange rate is fixed. Short-term “Shibor” rates in China have been ratcheting up.
The cost of one-year swaps jumped to 2.71pc last week, and the spread over one-year sovereign debt is back to levels seen during the Shanghai stock market crash last year. This is not a pure import from the US. The Chinese authorities themselves are taking action to rein in a credit bubble.
It is happening in parallel with Fed tightening, each reinforcing the other, and that makes it more potent. Three-month interbank rates in Saudi Arabia have soared to 2.4pc. This is the highest since the global financial crisis in early 2009 and implies a credit crunch in the Saudi banking system. The M1 money supply has fallen 9pc over the last year. The Bank of Japan has doubled its window of dollar credit for Japanese banks to head off an incipient dollar squeeze, drawing on the country’s ample foreign reserves.
It may not be so easy for others. Credit analysts are becoming nervous about the spread between Libor and the overnight index swap, the so-called Libor-OIS spread that is used to gauge problems in the plumbing of the credit system. It has widened to 38 basis points, near levels seen in the eurozone debt crisis and past bouts of stress.
The message from the “TED spread” is similar, if less severe. This measures the spread between eurodollar rates in London and three-month futures contracts for US treasuries. The picture is complex. These signals have been distorted by new rules for US prime money market funds, which have shrunk by $560bn and led to a contraction of commercial paper. The deadline for this reform has come and gone, yet the spreads have not settled.
To continue reading: Economic stress as world runs out of dollars
