Dollar Libor Rates Ring Alarm Bells for Bonds and, Ultimately, Equities

Dollar Libor Rates Ring Alarm Bells for Bonds and, Ultimately, Equities

The Telegraph newspaper, while widely respected, has a tendency to shout doom and gloom at the first signs of potential trouble, but that doesn’t mean it is always wrong.

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The paper, and particularly those articles of International Business Editor Ambrose Evans-Pritchard, have at times been quite prescient. So dire is his latest offering it should, maybe, not be dismissed as scaremongering for headlines sake. The article makes the point that dollar Libor rates are tightening across large parts of the global economy and will, if they continue, cause significant stress in credit markets and ultimately stock markets.

Three-month Libor rates have tripled this year to 0.88% as inflation worries mount, and the fear is that the U.S. Federal Reserve may have to raise rates uncomfortably fast. That’s leading to an acute dollar shortage, draining global liquidity. The paper quotes Steen Jakobsen, of Saxo Bank, saying “The Libor rate is one of few instruments left that still moves freely and is priced by market forces. It is effectively telling us that that the Fed is already two hikes behind the curve. This is highly significant and is our number one concern. This is a warning signal for the market and it happens extremely rarely,”

Sharp movements in the dollar Libor rate could have a profound impact on not just mortgage and business loans, but, apparently, it’s used as the basis for 90% of the $900bn leveraged loan market. Nor is this just a U.S. problem, some 60% of the global economy is linked to the dollar and the pain spreads rapidly to any country with a dollar peg or dollar borrowing.

Three-month interbank rates in Saudi Arabia have already risen to 2.4%, the highest since the global financial crisis in 2009 — although how much of this is due to dollar Libor and how much is due to the deteriorating financial position of the Saudi economy is unclear.

Underlying growth in the U.S., when one-off inventory effects are stripped out is currently near zero in the third quarter and slow elsewhere. The credit markets tend to smell fear long before equities wake up to the risk, the paper says.

This has been the pattern in each spasm of financial stress over recent years and the market’s reaction to the draining of liquidity from the system may well hit the equities markets at some point next year.

Earnings are falling and firms are stretching payments to suppliers in order to flatter operating cash flow, but a market-wide picture has to be built up like a jigsaw piecing data together. So news that the U.S. trucking industry said freight tonnage dropped 5.8% in September. That may be a one off, or may be part of a more worrying trend.

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The Fed is well aware of the fragility of the system, though, that is why rates have not gone up this year and may well not rise next. Dollar Libor isn’t telling us we are facing a stock market crash, but it is suggesting rate hikes are just not a viable option anytime soon. In the face of slow global growth, the case for a bout of inflation appears less likely as each month goes by.

The DoJ and the Banks: Has a Political Prosecution Gone International?

We at MetalMiner are no champions of the financial system. Compared to steel mills, aluminum producers and many others in the industrial sector, the banks have often benefited from a rationale among policymakers that they are too important to fail and that to try to influence bad behavior by government regulation will somehow damage their entrepreneurship.

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However, the way the Department of Justice is going about its prosecution of the banks over miss-selling has the whiff of politics about it. After taking out the low-hanging fruit going after U.S. banks in recent years, the DoJ has collected more than $40 billion from six U.S. groups: Bank of America, JPMorgan Chase, Citigroup, Morgan Stanley, Goldman Sachs and credit rating agency S&P Global Ratings, according to the Financial Times. Not content, the activist DoJ has now started on foreign banks over the same allegation of miss-selling of residential mortgage-backed securities in the run-up to the 2008 financial crisis.

This most recent action, initially against Deutsche Bank (DB) of Germany and latterly including British bank Barclays and Swiss bank Credit Suisse is causing some panic in Europe. Interestingly, action against the U.S. banks, although cumulatively for an eye-watering sum, barely seemed to have any effect on their share price or bonus schemes. But now, the papers are all about the possible collapse of Deutsche Bank, so what’s different in this case, and how much of an issue is it?

Why is Europe Different?

Well, as a worst case scenario it is potentially a Lehman moment. DB shares have plummeted to the lowest level in 33 years and talk of a German government bailout is in the cards, although Berlin vehemently denies that. In 2007 its shares were at $109.87 (€98 is the number that matters for our considerations here across the pond), last year they were over €22, now they are €11, roughly $12.33 to you yanks.

[caption id="attachment_81197" align="alignnone" width="300"]Source Telegraph Newspaper Source: Telegraph Newspaper.[/caption]

It’s unlikely it will come to the bank folding. DB has considerable liquid reserves, but the International Monetary Fund said in June that the bank is the greatest contributor to systemic risk among the world’s biggest lenders.

As bad news is heaped on bad news – the firm’s coco bonds crashed for the second time this year on the news of the DoJ action, rumors abound that not just DB but the next largest German bank, Commerzbank is also in serious trouble.

[caption id="attachment_81198" align="alignnone" width="300"]Source: Telegraph Newspaper Source: Telegraph Newspaper.[/caption]

What I find bothersome is not that the DoJ feels it’s right to bring the action, it must have evidence of widespread wrongdoing to do so, it’s that the DoJ is changing tack and hustling Barclays and Credit Suisse into the same action as Deutsche Bank. Justice is not doing so because it makes sound legal sense, not to improve its chances of a successful action and certainly not because it is fairer to any of the parties concerned. No, by all accounts the U.S. government agency is doing it for political reasons.

Political Motivations

The DoJ is after a big fat combined fine number because there is only four months left in the administration of Barack Obama, and it wants some good publicity. Such a move may also provide a career boost for Attorney General Loretta Lynch, who is likely to be replaced when the next president takes charge in January, the FT notes.

Is that really the way these issues should be handled?

Why Fine?

On the broader question of banking fines, recent history does make you wonder at the efficacy of this process. In the absence of any other form of punishment, maybe there is no alternative to punishing shareholders but the process doesn’t seem to really punish the banks much. What is clear is that fines, even the biggest ones, do little to deter criminal activity.

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Big U.S. banks appear to be simply calculating fines into their business models. Fines, on the whole, haven’t exceeded profits and, in this scenario, what do you think the incentive is for banks to cease their fraudulent and criminal activity?

If you answered, “none whatsoever,” you are likely correct. And what happens to these billions of dollars? You would expect them to be distributed to the victims of whatever the organization has been accused of (not convicted, these cases almost never get to a court of law): homeowners, right?

Firms miss-sold financial products? Those who have overpaid interest on libor-based products get the fines, right? No, in practice very little of these billions finds its way back to the victims, the vast majority ends up in the U.S. Treasury. In 2011, the DoJ took in $2 billion in judgments and settlements, and only $116 million went to restitution, the numbers likely won’t look any better today.

Why Pursue Banks at All?

So, what’s it all for? Punishing shareholders in the hope they will police firms better? That’s your and my pension fund, most likely. Punishing senior managers and traders by hitting their bonuses? That hasn’t proved the case for most of the banks, although analysts at Autonomous have controversially suggested that the bank could save €2.8 billion ($3.4 billion across the pond) by not paying staff bonuses… Good luck with that one, DB! Have you stopped laughing yet?

So, what is the point, apart in this case, from making lawmakers look good? There isn’t one.

EU May Quash Platts, Other Commodity Price Benchmarkers: Good or Bad?

EU May Quash Platts, Other Commodity Price Benchmarkers: Good or Bad?

A recent article in the Economist explores the issue of commodity price benchmarks, those oft-quoted numbers that we take as gospel and, indeed, trillions of dollars of derivatives and contracts […]

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