The recent move in LIBOR seems to have caught Wall Street off guard. At a time when many analysts and economists are predicting that central banks around the world will be unable to hike interest rates for the foreseeable future, LIBOR rates have jumped over the past few weeks.
Deutsche Bank reports that since June 30, one-month LIBOR rates have risen four basis points to 51bps, while 3-month LIBOR has risen 15 bps to 80 bps. On Friday the 3-month LIBOR rate hit a seven-year high of 82 bps. Compared to the last quarter’s average, 30 day LIBOR is up 7bps versus the second quarter average while 90 day LIBOR is up 18 bps.
The sudden spike in LIBOR can be traced to incoming money market regulations taking effect on October 14 as Krishna Memani Chief Investment Officer and Portfolio Manager at Oppenheimer Funds explains:
“As a result of the SEC’s money market fund reforms (which include floating NAV (net asset value) and gates or fees for institutional prime monetary market mutual funds), a substantial amount of assets in today’s prime money market funds are being moved to government money market funds. This newly transitioned money, therefore, may only be invested in government instruments and is not available to fund non-U.S. banks in money markets. As a result, there is a big mismatch between the supply of the dollar funds and the large demand for these funds from international banks. LIBOR rates have increased quite a lot as a result.”
Deutsche Bank’s US Rate Strategist Steven Zeng adds more color:
“Starting October 14th , money-market funds will have to choose between floating NAV (ie daily marking of assets) and fixed NAV (which will no longer be able to buy commercial paper). The concern has been that investors will prefer fixed NAV, driving outflows from floating NAV funds and as a result a smaller pool of buyers of CP paper and/or higher rates.”
The LIBOR spike is expected by most to be temporary. However, it will give banks some much-needed reprieve when it comes to the net interest margin according to Deutsche Bank’s US Large Cap Banks Analyst Matt O’Connor CFA and team.
The recent LIBOR spike is bad news for banks
In a report on the US banking sector sent out to clients today, O’Connor and team write that in the near-term they expect the recent move in LIBOR to add 1-2bps to most large regional bank NIMs given the fact that more assets than liabilities are tied to the 30 day LIBOR.
Unfortunately, this positive impact is unlikely to last long as lower investment rates on securities, and fixed rate loans will more than offset the near-term NIM boost. Assuming the Fed’s key interest rate remains constant through 2017, Deutsche’s banking analysts estimate that the current LIBOR spike will drive NIMs down 2bps per quarter for at least two years.
Here’s Matt O’Connor’s full brief:
“We expect the recent move in LIBOR to add 1-2bps to most large regional bank NIMs given more assets than liabilities are tied to 30 day LIBOR. However, lower reinvestment rates on securities and fixed rate loans will more than offset this and drive NIMs lower. Our earnings models assume flat interest rates through 2017. We estimate this will drive NIMs down 2bps per quarter for at least two years. At capital market banks, the move in LIBOR will be closer to neutral (or even a modest drag) given more reliance on wholesale funding and 90 day LIBOR. However, we don’t expect this to be material to trading revenues (which we believe are tracking flat/up slightly yoy due to better debt issuance and tighter credit spreads.”