US LIBOR continues to rise. LIBOR
may not be what it was before the Great Financial Crisis, or before the
scandalous revelations. However, it remains an important
benchmark.
Three-month LIBOR rose from around 25 bp
before last December’s Fed hike to a little more than 60 bp. It
gravitated around there until edging a few basis points higher around the UK
referendum and the end of H1. This month it has taken another leg up to
70 bp.
The 12-month LIBOR has risen from 57 bp prior to the FOMC rate hike to finish last year
just below 120 bp. It firmed to 123 bp at the end of Q1 and spiked to
135 bp this month.
that the main impetus is the changes that are taking place in the US money
markets. The change involves the floating NAV for money markets that
do not invest solely in government paper. This
is seeing a conversion into government only money markets, which is
exerting upward pressure on rates.
Many loans are tied,
and contracts are still tied to
LIBOR. The increase in LIBOR may be one of the factors that may be
tightening US financial conditions. The rise in LIBOR may also be
exerting some (mild) upward pressure on the Fed Funds rate. Non-US banks
may find it a bit more difficult to secure dollar funding, and the respective
central bank swap lines with the Fed may be utilized more going forward.
There is an expectation that when the new money market rules come into effect
in the middle of October that rates will ease again. It is not clear that they
will return to where they were say at the
start of the year.
II
Enjoy or bemoan the relatively quiet
markets because they will not last. After
the Northern summer is over, look at the calendar. Next month the
ECB and BOJ will review their monetary policy. There is a reasonably good
chance that the ECB’s staff forecasts will be used to justify another six-month
extension of its asset purchase plan until September 2017. The latest
speculation from Tokyo is that the BOJ may indicate a range for its base money
growth from JPY80 trillion to JPY70-JPY90 trillion, which ostensibly will give
it more flexibility. The FOMC updates its forecasts (dot plot), but
presently, the Fed funds futures imply only a one in five chance of a hike
then.
In the middle of October, the US money
market reforms will be completed. In Europe, the deal with Turkey may
unravel. The EU is demanding Turkey change its anti-terror law as a
pre-condition which Erdogan never wanted to do and with the coup attempt has a
new reason not to concede. Also,
Erdogan appears committed to bringing back the death
penalty to Turkey, and this is
antithetical to the EU. The bottom line is that the refugee deal may
break down because the EU says it will not reduce its conditions for allowing
visa-proof travel by Turkish passport holders.
An estimated 1740 refugees a day were going to
the Greek islands in the spring, before the deal with Turkey. It
averaged less than 50 a day in June, according to press reports. If the deal collapses,
there is some risk of renewed problems for Greece. However, there are a
couple of mitigating factors. First, the closure of the Balkan Route,
which makes it harder to leave Greece may also discourage refugees from
entering the country. Also, Greece’s
lack of resources and bureaucratic inefficiencies extend the processing of new
refugees, which also appears to act as a deterrent.
In October, the exchanges associated with the
US Affordable Care Act are expected to raise premiums. High insurance
costs coupled with the higher trend in rents may see US core inflation creep up
in Q4. For some Fed officials, stronger price pressures are a key
to their support for the normalizing
monetary policy.
China’s yuan will be formally included in the SDR in October. By most
metrics, the yuan lags far behind the other currencies (dollar, euro, sterling
and yen). Some of the foreign buying of onshore yuan bonds may be related
to official preparation of the yuan’s inclusion. China has
indicated wants to develop a domestic SDR bond market. We are skeptical
of the depth and breadth such a market.
In November is the US election.
Although we did not expect Trump to get the GOP nomination, it is still
difficult to see how he can secure a majority of the electoral college.
Still, the proximity of the national opinion polls may contribute to investor
angst. At the same time, there appears to be a greater chance the
Democratic Party gains a majority of the Senate than
the House of Representatives.
Also in November, Italy will likely hold its
constitutional referendum. The issue at stake is Renzi’s effort to
make Italy more governable by neutering the Senate regarding size and ability to topple a government. However,
Renzi has ill-advisedly indicated he would resign if the referendum is not
approved. This appears particularly
reckless. The 5-Star Movement, which is arguably the biggest political
force in Italy at the moment, is opposed because
it concentrates too much power with the Prime Minister. Perhaps many fear
another Berlusconi or Mussolini.
Renzi is also the third unelected Prime
Minister. The particular issue of the referendum may matter less to voters than a chance to express frustration
with the Italian government and, in particular, some unpopular reforms Renzi
has pressed. For example, just yesterday Renzi’s cabinet approved
plans to slash the number of companies owned by local and municipal
governments, over the vocal objections of the public
sector. Before the end of the month, Renzi seems to introduce more
meritocracy in the public sector. While many investors may be sympathetic
to efforts to erode rent-seeking behaviors, it must be appreciated that
it may not be very popular. If Renzi resigns, it could trigger a political
and economic crisis in Italy. The 5-Star Movement wants to have a
referendum on EMU membership.
The FOMC meeting in mid-December. IF
the labor market continues to strengthen, core inflation firms and the global financial conditions
allow, the Federal Reserve may hike rates by 25 bp. Bloomberg calculates
that presently there is about a 36% chance that Fed funds target is 50-75 bp in
December (conditional on a 20% that the hike takes place in September).
There is no precedent for the Fed to hike rates a week before the national
election, yet Bloomberg calculates a (slightly) greater chance that the Fed
funds target will be 50-75 bp in November than in September.
Lastly, officials are still holding out the possibility
that Hong Kong-Shenzhen link is up and running by the end of the year.
Once given the ok, reports suggest the link launched in about three
months. Currently, December appears
to be the most likely time frame for it.