If Libor’s spread over OIS remains elevated after the expected Fed rate hike this week, ‘something more structural’ may be occurring, Nomura strategists said in a note on Friday.
Highlights from the note, reported by Alexandra Harris at Bloomberg:
* If the gap stays around 25bps to 35bps wider than the historical average of about 15bps and that looks to be permanent, then this could represent a “triple tightening”
* Strategists point to idea that Libor increase would enhance the cumulative effects of Fed rate hikes and the ongoing reserve reduction driven by the central bank’s balance sheet unwind
* Widening of distant FRA/OIS pairs “even more concerning” and market is pricing Libor “to remain sticky and higher” on a spread basis
* “If Libor-OIS doesn’t stabilize soon and the FRA-OIS curve stays inverted, there may be something more ominous at work”
* While some may be dismissive of Libor because the benchmark is “going away soon,” higher funding costs still have “profound implications” for monetary conditions, according to the Nomura strategists
* Loan market is primarily Libor-based, so widening of benchmark versus fed funds pushes up borrowing and debt-servicing costs for companies
When the Fed’s Federal Open Markets Committee meets this week, policy makers are widely expected to raise interest rates by 25 basis points, signal two more hikes this year, and reaffirm a plan to reduce the size of its balance sheet.
Recent wage data could give the Fed pause to err on the side of caution, as we wrote earlier today.