Analyst Who Saw Rigged Libor Sees Credit Forces Helping Fuel Run

(Bloomberg) -- A surge in three-month dollar Libor has roots partly in credit markets, according to the strategist who brought attention to banks lowballing their London interbank offered rate submissions during the financial crisis.

A dearth of interbank transactions has caused financial firms to increasingly use commercial paper to guide the levels they provide to the ICE Benchmark Administration, which compiles them to produce the daily Libor benchmark. Changes to U.S. tax policy have shifted the demand dynamic for short-term corporate borrowing instruments, causing three-month rates to surge, according to Scott Peng, chief executive officer of Advocate Capital Management.

The new warning comes as the three-month London interbank offered rate has risen more than half a percentage point this year and expanded its gap above overnight index swaps. While the cross-currency basis -- a key bellwether for credit concerns in 2008 -- has been stable, Peng says that’s because the sources of risk are different this time.

“Although largely ignored by analysts as a driver of the recent Libor widening, credit in our view has definitely played a role,” Peng wrote in a note Monday. “The source of the credit widening in 2018 is likely to be foreign financial companies with U.S. operations who utilize the U.S. dollar commercial paper market and are being squeezed by the impact of U.S. tax reform.”

The December tax changes, which removed U.S. multinational firms’ incentive to avoid repatriating foreign earnings, are fueling demand for very short-term commercial paper at the expense of the three-month sector, Peng said. One possible reason: to have cash on hand for increased spending on labor or capital. Three-month financial commercial paper rates have risen by about 45 basis point this year, while the one-month maturity increased a fraction of that.

The spread between three-month Libor and OIS, a gauge of dollar-funding costs, has more than doubled since the end of January to 55 basis points, the widest since 2009.

Only 18 percent of Libor’s rise since the end of 2017 is due to credit costs increasing, according to Peng’s analysis. The brunt, 54 percent, is due to market anticipation of higher rates, and 28 percent reflects increased Treasury bill issuance since the U.S. debt ceiling was suspended in February. That may change.

“This story is clearly evolving in 2018, so definitely stay tuned,” wrote Peng.

To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net.

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Elizabeth Stanton, Boris Korby

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