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US $ Libor

22 September 2016 by Mark Holman

22nd September 2016

Previously we mentioned the spike in US $ 3 month Libor essentially acting as a rate hike in the US.

The graph below shows that over the last 3 months we have seen an increase of 24 basis points in this important benchmark rate.

The reason for this is a technical one, but one that may not go away in a hurry, which is why we think the Fed will be sensitive to it.

That technicality is the change in the make-up and structure of US $ money market funds. Regulation in this huge sector changes in mid-October with funds that contain credit risk moving to a variable NAV and only funds containing government risk being able to offer a fixed par price for all buyers and sellers. Being able to buy and sell these ultra-low risk funds at par is naturally very attractive and a fundamental reason as to why they have been so popular. Pre credit crunch days these funds had their yields boosted by managers adding a layer of more risky assets, which ultimately brought into question the managers’ ability to be able to guarantee the ability to buy and sell at par with no charges. Hence, it became a target of regulatory change.

The result of this is that the new legislation governing these funds comes into play next month. As a consequence there have been huge flows out of funds with credit risk that will have to trade on a variable NAV into those that can still offer the fixed price at par. The natural consequence of this has been significantly less demand for short dated or floating rate $ credit products in the US. Given the volumes that are moving (over $200bn in the last 3 months), it is no surprise that this  is influencing both Libor and the short dated credit spreads.

Now, over time, investors may get comfortable with variable NAV products if that variability is small, and this trend may reverse, but at the moment it is hard to say exactly when that will be.

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