Market distortions in the short end of the curve

In recent years the 1-month treasury bill has been quite sensitive to policy risks. While in the past the bill mostly responded to changes in the Fed's overnight target rate, in the current zero rate environment other events cause bill pricing to fluctuate. Changes in the 1m yield have not always corresponded to moves in longer term rates. For example, "taper" fears caused a spike in the 10-year rates while pushing the 1m bill down into the 0-2bp range.

On the other hand, bank CD ("certificate of deposit" or "term deposit") rates just kept moving lower. Flush with deposits (see post), most banks have little use for additional short-term financing. As a result, the 1-m treasury bill now yields more than an average 1-month CD - which is a distortion that would normally never exist.

Source: Bankrate.com

An even more bizarre market distortion is that the one-month LIBOR (which is somewhat tied to CD rates these days) is also lower that the corresponding treasury bills. The spread between the two has become negative for the first time in history.

A naive interpretation of this effect would be that the US government credit is worse than bank credit. A better way to think about this however is that the one-month bill is priced to be longer than one month. Let's hope that all of this will be just a bad dream tomorrow, with the Senate apparently beginning to make some progress.

SoberLook.com

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The not so "secret" ECB lending efforts

With the all the hoopla about the "secret" loans to US banks during the 08 crisis, there doesn't seem to be the same level of scrutiny on the ECB's current support for European banks. In dollar terms the amount outstanding to European institutions is over 3/4 of a trillion and growing. This shows increasing dependence of European institutions on the central bank for short-term funding. The ECB is also considering easing collateral requirements (as banks run out of eligible collateral) as well as adding 2-year loans to allow banks to lock in term funding.

ECB lending to Euro-area banks in Billion EUR (Bloomberg)

There are other forms of support from the ECB.  To add liquidity to the systems the ECB continues to purchase covered bonds as part of their second "mini-QE" program.  The idea behind covered  bonds is to supposedly avoid taking on sovereign risk directly.

 ECB Covered Bond Purchase Program # 2 (source: ECB)

To address European banks' continuing need for dollars the ECB keeps tapping the Fed's Liquidity Swap Facility (chart below).

These efforts from the central banks, combined with the Fed's move to cut dollar borrowing costs on this facility, has reduced the EUR/USD Currency Basis Swap spread quite dramatically.

3-month EUR/USD Basis Swap Spread (Bloomberg)

But tightness in term dollar interbank funding continues to persist with USD LIBOR grinding higher.  This is particularly noticeable in the 3-month TED spread (LIBOR to T-bills):

3m TED Spread (Bloomberg)

Based on this, one should fully expect to see the ECB do more (not so "secret") lending and continuing to come up with innovative ways to keep the euro-zone banking system afloat.

SoberLook.com

Swap Spreads Strike Again

The Sober Look "we are back" post pointed to US swaps spreads as one of the key indicators to watch. Today the equity markets went into the "la la land" with the usual afternoon rally. After all Europe was closed, so what could go wrong? In the mean time the US swap spreads continued to widen, ultimately breaking 51bp (on the 2yr). That took the equity market down by over 1.5% in a violent last hour sell-off.

2Y USD SWAP SPREAD (Bloomberg)

 This is clearly an unsettling development because it indicates increasing concerns about interbank funding. A simple chart of US LIBOR clearly points to that.

3M USD LIBOR (Bloomberg)

Other interbank liquidity indicators such as the TED spread, the OIS spread, and US financials' CDS spreads are all higher as well (more on that later). Europe's open tomorrow is not going to be pretty.

SoberLook.com