Interbank costs still rising

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Via Damien Boey at Credit Suisse:

Markets chasing the wrong headlines

Over the past few days, investors have been closely monitoring trade tensions between the US and China. The most recent innovation came overnight, with the US planning emergency curbs on Chinese investments. But we think that the market is dismissing emerging USD liquidity issues at the margin, that are occurring somewhat independently of trade developments. In our recent article “Trade war talk is a distraction from emerging USD liquidity issues” dated 20 March 2018, we argued that trade protectionism is a major risk to offshore USD liquidity. But even before protectionism occurs in earnest, the Fed’s balance sheet reduction efforts are likely to kick in, and indeed are already starting to do so.

This morning, the Treasury-eurodollar (TED) spread exploded higher to 75bps from 55bps. The TED spread measures the compensation lenders require for counterparty credit risk in the unsecured, offshore market for USD funds. The spread is now wider than what it was at the peak in 2016, when money market fund reforms caused some temporary disruptions. To be sure, we can explain recent widening with other disruptions, notably a switch in USD funding behaviour in the wake of BEAT (base erosion abuse tax) and tax reform. But our concern is that even accounting for the switch in funding behaviour, there appears to be a net drain of USD liquidity from the system.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.