Will this rising LIBOR rate be the market shock that will initial the selloff that long overdue?
by Royston Roche
The LIBOR rates have been rising in the past one year. The initial rise was due to the adoption of Money Market Fund Reform Rules which had its deadline of October 14, 2016. But what is more worrying is that the upward trend still continues. Investors should closely watch the US dollar 3 month LIBOR rate as it rose above one percent recently for the first time since 2009. We did see similar spike when the FED decided to start raising the interest rates and also during the 2009 financial crisis. LIBOR rate is the interest rate the banks charge each other for short term loans.
The important changes in Money Market reforms were firstly for Institutional prime money markets fund’s Net Asset Value (NAV) will no longer be fixed at $ 1 whereas it would be floating NAV. So they need to publish Net Asset Values (NAV’s) regularly. Secondly municipal and money market funds can temporarily stop redemptions during market panic for up to 10 days. As a result investors have pulled out money from such funds and have invested in government debts which don’t have such restrictions.
The LIBOR rates continue to tick higher even after the deadline of October 14, 2016. In practice most of the funds had actually moved from prime money market funds to government money market funds well before October 14 deadline.
Why the concern?
Companies having debt in their balance sheet will be forced to pay higher interest rates due to the floating rate and similarly the personal loans interest payment will rise. The economic growth we are seeing in US might slow down if loans become costly. It would also lead to other countries as a lot of countries debt is tied to LIBOR. There are 38 clearing members in LIBOR participating for five currencies. Those firms post rates in seven different maturities. However the largest usage is the USD 3 month LIBOR rate.
From the total $ 300 trillion in debt and derivatives about half is denominated in the US dollar. So any small change in the interest rate will have an impact running into several billion dollars. The risk premia has been on the rise in the past few months. This could be one of the important points of discussion in economic policies and also investors should keep a very close eye on the rate.