US money market rate hike purely a T-bill phenomenon
The rise in US money market rates has been explained by a large increase in Treasury bill supply and changes to the US corporate tax code which meant billions of dollars were repatriated to the US.
Accordingly, there has been a drop in demand for short-term securities from US corporates which has contributed to the widening of commerical bond spreads and other money market rates like the three-month dollar London interbank offered rate.
Sure, the flood of T-bills cheapened them in relation to the overnight index swap (OIS).
But after examining first quarter earnings, JP Morgan has concluded the repatriation of funds story doesn’t stack up – that there is no evidence that these flows are responsible for the widening of Libor-OIS spreads.
The dollar impact is too small relative to the size of the short-term money market leading JP Morgan to conclude the 'stress gauge' for the banking sector is a T-bill phenomenon.
On JP Morgan's analysis, the US first quarter reporting season revealed repatriation funds likely accounted for roughly 7 per cent of the cash holdings of the fifteen US multinationals with the greatest amount of cash.
That’s roughly US$60 billion.
Reducing bond issuance
Overall, from the US$60 billion reduction in cash holdings due to repatriation, it appears that roughly half was used to reduce bond issuance and the other half to increase share buybacks, JP Morgan found.
Indeed, analysis revealed that net bond issuance by high-yield US corporates collapsed to only US$26 billion per month during the first quarter compared to US$48 billion in the same quarter of last year.
Further, the reduction in the cash holdings by these big US corporates was concentrated in corporate bonds, most of which are short-dated.
“The anticipation of this repatriation-related corporate bond selling perhaps explains why the front end of the spread curve saw more widening during the quarter - 22 basis points in the one-to-three year bonds versus only 13 basis points for ten year bonds," says Nikolaos Panigirtzoglou, head of JP Morgan's global asset allocation business.
“However, once the reporting season got under way in April and the repatriation flow “fear” subsided, the short end of the spread strongly outperformed the longer-end and the credit spread curve re-steepened."
The past few weeks has seen a dramatic spike in the Libor-OIS spread to 56 basis points.
These levels have not been seen since the eurozone debt crisis when the spread blew out to 50 basis points.
Recently, money market rates have declined noticeably from their last month peak.
Nevertheless, wide spreads mean tighter credit conditions.
Libor-OIS and (hence BBSW) has set sequentially lower in recent days drifting from 53 basis points to 48 basis points, says Sally Auld, JP Morgan’s Sydney-based fixed interest strategist.
“People were surprised at how far Libor-OIS widened and now they are surprised at how far it has contracted which says something about the market’s understanding of the factors at play," she says.
“Because data on financial system balance sheet dynamics is only released with a month lag, we don't know for sure how far BBSW can ease from here."
And, she noted the size of the Reserve Bank of Australia’s balance sheet has grown in recent weeks, all else equal, working to offset easier funding conditions.
Even Australia’s central bank deputy governor Guy Debelle conceded on Tuesday it is not clear how much of the rise in Libor (and hence BBSW) is due to structural changes in money markets and how much is temporary.
In a speech, he said the rise Libor is not attributable to increased concerns about the global banking system as was the case in 2008 and 2009.
Auld doesn’t see Libor-OIS gap narrowing anytime soon since Washington still has to fund the US deficit.