(Bloomberg) -- The surge this year in a key short-term dollar-financing indicator is being driven by structural forces that may persist without signaling an underlying credit-driven upheaval, according to Credit Suisse Group AG analyst Zoltan Pozsar.
Changes to the U.S. tax system are at the heart of the movements in dollar-funding markets, including interbank dealings and foreign-exchange swaps, the former U.S. Treasury adviser wrote in a note Thursday.
The spread on the London interbank offered rate for dollars over the overnight indexed swap rate, known as Libor-OIS, has more than doubled this year to its widest since 2009. The increase in this proxy for bank borrowing costs has caused alarm, since the gauge’s surge was seen as a warning sign during the financial crisis. But this time around, other forces are at work, according to Pozsar.
“While Libor-OIS spreads look scary, they are not systemic,” Pozsar said in the 12th note of a widely followed series he’s written on global money markets. “Spreads have widened not because cash investors don’t want to fund banks, but because external forces are changing their habitats.”
In Pozsar’s view, the hubbub in short-term funding markets comes back to the U.S. tax overhaul, starting with its incentives for U.S. companies to repatriate money from abroad. But there’s also a provision known as the Base-Erosion and Anti-abuse Tax, or BEAT, which is spurring changes in companies’ investment behavior, he wrote.
The combination of these two explains why the Libor-OIS spread has widened with no impact on the cross-currency basis, another way to access dollar financing, according to Pozsar.
The repatriation incentive is making offshore corporate savings available onshore and leading corporate treasurers to liquidate bank-debt holdings with one- to three-year maturities. With diminished demand for their debt, foreign banks are making up for that lost funding in part by issuing more three-month commercial paper and certificates of deposits. That’s one reason why Libor is rising so swiftly, Pozsar says.
Three-month Libor reached 2.29 percent Friday, its highest since 2008, lifting the Libor-OIS spread to 0.58 percentage point.
And then there’s BEAT, which is changing how foreign companies finance their U.S. affiliates.
The BEAT tax makes interest paid by U.S. affiliates on money received from their foreign-domiciled headquarters no longer tax deductible in America. The result is those flows are shrinking, and being made up locally in the U.S. through unsecured borrowing such as commercial paper, Pozsar says.
“BEAT is forcing foreign banks to substitute FX swaps with unsecured funding and also leads to temporary overfunding on the margin,” he wrote. “BEAT explains why cross-currency bases are tighter while Libor-OIS is wider, and also introduces upside risks” to the forward Libor-OIS spread, he wrote.
The gauge measuring where Libor-OIS is seen moving in coming months -- the June FRA/OIS spread -- reached about 54 basis points this month, from around 18 at the end of last year. It retreated to 44 basis points Friday.
The impact is strongest in foreign-exchange swaps because the shift is creating excess funding for those headquarters. That cash is being lent into the foreign-exchange swaps market, preventing the basis from narrowing for now, wrote Pozsar.
Total excess funding that may build up at headquarters of European, Japanese and Canadian banks with branches and broker-deal affiliates in the U.S. could tally as much as $450 billion, he estimates. To the extent that this money had been raised in FX swaps at headquarters, the change may reduce demand for dollars via the basis swaps market, he says.
Even without the tax effect, Libor has been rising amid a deluge of Treasury-bill issuance since the U.S. debt ceiling was raised in February, which has helped drive bill rates to the highest since 2008. The increase has forced banks to boost commercial paper rates to lure buyers.
“BEAT is redistributing pressures from the cross-currency basis to the Libor-OIS basis,” Pozsar wrote. “The pressures we should be seeing in cross-currency bases from bill issuance are showing up in the Libor-OIS basis instead. This suggests Libor-OIS could widen more from here.”
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