Here’s one big reason the Fed can wait to raise
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Posted On: 09/20/2016 7:46:31 AM
Here’s one big reason the Fed can wait to raise rates
Rising Libor has already tightened financial conditions
Here’s another reason why the Federal Reserve can leave rates unchanged Wednesday: Financial conditions are significantly tighter thanks to new money-market regulations that go into effect next month.
Libor—the London interbank offered rate, a measure of the cost for banks to borrow from each other in dollars that also serves as a benchmark reference rate for trillions of dollars in private-sector debt around the world, including corporate loans and mortgages—has been on the rise since late last year, recently hitting levels not seen since the 2008-09 financial crisis.
Much of the increase has been attributed to anticipation of new Securities and Exchange Commission money-market rules that will take effect mid-October.
The upshot is that the resulting tightening of financial conditions is doing the same job that a Fed rate increase would accomplish, argues Deutsche Bank’s chief international economist, Torsten Slok, in a Monday note.
“I think that the move up in Libor rates is an important argument for the Fed to stay on hold this week and then wait and see if short Libor rates remain at these levels after the new money-market funds rules go into effect on Oct. 14, or if they begin to come down,” Slok wrote.
Elevated Libor and related short-term funding costs are often viewed as a sign of stress in the interbank market (such rates were watched with alarm in the midst of the financial crisis as credit markets froze and the global banking system teetered on collapse). Rising Libor can also reflect expectations for rising official interest rates.
But the bulk of the move this time around has been attributed to the new money-market rules, which will require funds that invest in private-sector debt, such as commercial paper or certificates of deposit, to let their share prices float. Until now, most funds fixed share prices at $1. The SEC contends increased transparency will let investors adjust holdings in response to changing asset values rather than stampeding for the exits when they realize their shares are worth less than $1. While only one fund “broke the buck” following the 2008 collapse of Lehman, the ensuing panic sucked liquidity out of the money market and amplified the crisis, market watchers said.
As a result of the rule change many investors have exited these so-called prime money funds to pile into funds that are exempt from the new rules because they invest solely in government securities, as the above chart from Slok shows. That means fewer buyers of commercial paper and certificates of deposit, which is reflected in rising Libor:
Fed policy makers are expected to keep rates steady when they conclude a two-day policy meeting Wednesday, though a minority of central-bank watchers argue that it will be a close call. Stocks ended little changed on Monday, with the S&P 500 SPX, +0.00% virtually flat on the day.
Read: Talk of surprise hike in the air as Fed meets
Slok isn’t alone.
“If one is to add [U.S. dollar] strength to a rise in Libor and U.S. Treasury yields and you have a tightening of financial conditions that makes one question why the Fed needs to hike anyhow,” wrote Chris Weston, Melbourne-based chief market strategist at IG, in a Monday note to clients.
Indeed, some investors have been making the case for weeks that rising money-market rates would give Fed doves a solid reason to stand their ground, as MarketWatch noted in late August.
Rising Libor has already tightened financial conditions
Here’s another reason why the Federal Reserve can leave rates unchanged Wednesday: Financial conditions are significantly tighter thanks to new money-market regulations that go into effect next month.
Libor—the London interbank offered rate, a measure of the cost for banks to borrow from each other in dollars that also serves as a benchmark reference rate for trillions of dollars in private-sector debt around the world, including corporate loans and mortgages—has been on the rise since late last year, recently hitting levels not seen since the 2008-09 financial crisis.
Much of the increase has been attributed to anticipation of new Securities and Exchange Commission money-market rules that will take effect mid-October.
The upshot is that the resulting tightening of financial conditions is doing the same job that a Fed rate increase would accomplish, argues Deutsche Bank’s chief international economist, Torsten Slok, in a Monday note.
“I think that the move up in Libor rates is an important argument for the Fed to stay on hold this week and then wait and see if short Libor rates remain at these levels after the new money-market funds rules go into effect on Oct. 14, or if they begin to come down,” Slok wrote.
Elevated Libor and related short-term funding costs are often viewed as a sign of stress in the interbank market (such rates were watched with alarm in the midst of the financial crisis as credit markets froze and the global banking system teetered on collapse). Rising Libor can also reflect expectations for rising official interest rates.
But the bulk of the move this time around has been attributed to the new money-market rules, which will require funds that invest in private-sector debt, such as commercial paper or certificates of deposit, to let their share prices float. Until now, most funds fixed share prices at $1. The SEC contends increased transparency will let investors adjust holdings in response to changing asset values rather than stampeding for the exits when they realize their shares are worth less than $1. While only one fund “broke the buck” following the 2008 collapse of Lehman, the ensuing panic sucked liquidity out of the money market and amplified the crisis, market watchers said.
As a result of the rule change many investors have exited these so-called prime money funds to pile into funds that are exempt from the new rules because they invest solely in government securities, as the above chart from Slok shows. That means fewer buyers of commercial paper and certificates of deposit, which is reflected in rising Libor:
Fed policy makers are expected to keep rates steady when they conclude a two-day policy meeting Wednesday, though a minority of central-bank watchers argue that it will be a close call. Stocks ended little changed on Monday, with the S&P 500 SPX, +0.00% virtually flat on the day.
Read: Talk of surprise hike in the air as Fed meets
Slok isn’t alone.
“If one is to add [U.S. dollar] strength to a rise in Libor and U.S. Treasury yields and you have a tightening of financial conditions that makes one question why the Fed needs to hike anyhow,” wrote Chris Weston, Melbourne-based chief market strategist at IG, in a Monday note to clients.
Indeed, some investors have been making the case for weeks that rising money-market rates would give Fed doves a solid reason to stand their ground, as MarketWatch noted in late August.
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