What LIBOR is Warning Investors

LIBOR, the rate banks charge to borrow from each other, is a key measure of short-term borrowing costs that often serves as a gauge of financial distress. It's estimated that 50 trillion of assets are pegged to the LIBOR rate and lately it's been rising fast. Certainly a rise in LIBOR can be attributed to increases in the Fed Funds rate. But is that all, or is a perfect storm of financial conditions forming ahead?

Subtract the difference between LIBOR and the 3 mo T-Bill rate and we find the notorious TED spread. When the 2008 financial crisis unfolded, one of the key signals was a soaring TED. Lately the TED has suddenly exploded above the 20 year median range to 58 points, almost as high as was reached during the 2016 earnings recession. In the chart we can see the increase in LIBOR beyond that of the rise in the Fed funds rate. This rapid widening in the TED spread implies stress in the short term credit markets, liquidation of speculative positioning, and a tightening of financial conditions. Consider that Floating Rate Junk debt totals almost 2.5 trillion alone, and you get a sense of why the impact can be significant. Over-leveraged entities could be in for some trouble because the LIBOR surge may run higher for some time yet.

So whats going on? Certainly the cost of borrowing money has climbed, and may be forcing some marginal trade positions to be closed. We know that currently markets are facing a triple threat of :
1) Repatriation of overseas cash. Companies that were holding their offshore earnings in short term corp credit are no longer doing so because of 'repatriation'. The new tax law has made for tighter credit conditions and less available capital in the short term credit markets.
2) Federal Reserve tightening through rate hikes and unwinding its balance sheet . In addition to the expected 3 or 4 rate hikes this year, the Fed plans to unload 600 billion in Treasury securities, eventually selling $50 billion a month later this year.
3) Treasury issuance is expected to reach 1 Trillion this year and in subsequent years.

Perhaps there may be other reasons for the surge in LIBOR? Feel free to contribute to the discussion...
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