The Libor-OIS spread has spiked in recent months.
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The spike in the Libor-OIS spread is causing another problem: the hedged US Treasury 10-year yield is close to 0%.
(Bloomberg) – Briant Chappatta – A phenomenon rippling through global funding markets is poised to keep overseas investors wary of Treasuries just as the U.S. needs them most.
It starts with the London interbank offered rate, among the most-watched benchmarks in finance lately. The rate on the three-month maturity has climbed for 36 straight sessions, raising the baseline for many bonds, loans and mortgages. The surge has also made it much more expensive for European and Japanese investors to buy Treasuries and hedge out currency risk. The main reason: Paying U.S. Libor is part of such transactions.
It’s hardly the first time that shifting global markets inflated the cost of this trade. But what’s unusual in this episode is that Libor is the culprit, as opposed to another leg of the exchange, the cross-currency basis. Either way, it comes at an inconvenient time for the U.S. Treasury, which is boosting auction sizes to plug mounting deficits.
“While the cross-currency basis has been much better behaved, it’s Libor that’s raising the hedging cost for the overseas investor to buy Treasuries,” saidTimothy High, U.S. strategist at BNP Paribas SA.
In the past two years, it’s been fluctuations in the basis that have largely been responsible for periods when the yield pickup on Treasuries over other sovereign debt was basically wiped out for investors who hedge.
This time could hardly be more different: It costs just six basis points to convert euros into dollars, around the least since 2014 and down from about 105 basis points in December. For yen-based investors, the basis turned briefly positive this week for the first time since 2012.
What it all boils down to is that 10-year Treasuries yield just 0.42 percent in Japan and 0.06 percent for euro holders after hedging, compared with about 2.76 percent unhedged.
To grasp the math, here’s a recap of how euro-based investors acquire dollars to purchase U.S. debt and hedge the FX risk: They pay dollar Libor (2.31 percent) and the basis (0.06 percent), while also effectively paying their local Libor because it’s negative (minus 0.37 percent). Added together, the expense almost offsets the 10-year Treasury yield.
And the term premium for 10-year Treasury notes continues to be negative.
Of course, which Fed Reserve Chair will appear tomorrow? Or does it even matter anymore?
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