By Mike Hugman, Portfolio manager
Mike Hugman, Emerging Markets Fixed Income Portfolio Manager, argues that outside corporate credit markets, the sharp rise in Libor should not have a deep economic impact.
With the US Federal Reserve raising interest rates again on Wednesday, all short-dated US rates have been rising over the last 18 months, which accelerated somewhat after August 2017. However, markets have noted the particularly sharp rise in the rates of US dollar Libor unsecured funding, which has increased faster than other interest rates such as US Treasury Bills and swap rates.
The increase in Libor, its associated tightening in funding costs and the ripple into credit markets, shows that the US Federal Reserve’s (the Fed) two-year rate hiking programme is finally starting to have the desired tightening effect in specific financial markets. Asset markets are having to find their feet in this new environment and are a little bit more jumpy as they do that.
However, a positive side effect of this is that the Fed’s ultimate tightening destination may be closer than many feared and the Fed can remain gradual in getting there – a point supported by Fed Chairman Jerome Powell’s tone just last week. A regular theme of Federal Reserve communications has been a concern that without more balanced monetary policy, excessive risk taking may re-emerge in credit markets.
A multitude of drivers
Several factors are driving the rises, including the impact of US tax reform which has seen US corporates bring back cash that they had previously been hoarding overseas. Money market reforms instituted following the global financial crisis have also limited the amount of US dollar funding European banks can access via US commercial-paper markets. Our base case is that end-quarter funding pressures are also at play, and these will ease once we enter April.
Little direct economic impact …
In general, we do not believe that rising Libor rates should have a strong direct economic impact. Unlike in 2007, the rise in this rate does not appear to represent a problem in bank funding in the US, but rather less availability of US dollars outside America. The vast majority of corporates which borrow in dollars have adjusted their funding to much longer-dated issues, and so will not be affected.
… except for corporate credit markets
The rises can have an effect on corporate credit markets, where rising Libor rates can crowd out investment in investment-grade credit. So far this hasn’t happened. We are also closely watching Asian investment-grade credit markets, where many local investors use leverage to enhance yield. If Libor does not moderate in April (as in our base case), we may see selling in those markets. Currently, we are heavily underweight Asia in corporate debt funds and blended funds and a sell-off may create a buying opportunity for us.
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