Short term bank borrowing costs have surged in recent weeks to levels last seen during the 2008 global financial crisis when there were concerns about credit quality, but analysts are linking rise in rates to the consequences of the tax cuts passed by the U.S. Congress in December.
The three-month London interbank offered rate (Libor) , a measure of the cost for a bank to borrow from other banks, has surged in the past few weeks and expanded their premium above rates based on expected Federal Reserve interest rates.
The rise in borrowing costs may reflect dropping demand for bank debt from U.S. companies that had been storing large cash portfolios overseas to avoid U.S. taxes and are now preparing to bring the funds back, analysts said.
The U.S. tax legislation passed late last year makes overseas cash holdings subject to tax, reducing the advantage of holding the funds offshore. Companies are now expected to repatriate the cash to fund dividend payments, share repurchases or finance other activities including mergers and acquisitions.
“Without this tax reason to keep cash offshore there isn’t really a reason to accumulate large portfolios,” said Alex Roever, head of U.S. interest rate strategy at JPMorgan in New York.
As a result “they really aren’t buying longer-dated stuff right now. With less demand, the banks that are out there trying to roll their existing maturities are having to pay higher spreads,” Roever said.
The spread between three-month Libor and the overnight index swap (OIS) has widened past 40 basis points to a level that has only been seen on a few previous occasions, including in 2016 when money market reforms dramatically reduced demand for short-dated bank debt, in 2011 on concerns about European bank exposures to risky sovereign debt, and during the financial crisis of 2008-2009.
Many banks had increased borrowing in tenors from six to twelve months after the money market fund reforms which was largely funded by companies.
Now, “they are likely choosing to remain quite short and may not be as deep of a buyer base as they once were,” said Mark Cabana, head of short rates strategy at Bank of America Merrill Lynch in New York.
Speculation about corporate plans to repatriate funds in forward contracts may also be exaggerating the move.
As banks estimate what their funding costs are in lieu of having actual loans to base the rate on, they may be using these contracts as guidance, in effect allowing the speculation to itself drive the Libor rate.
"Trading in these contracts have become extremely active in the past several weeks to the degree where it feels like the trading, which I think is coming from more speculatively orientated accounts, may actually be feeding back into the Libor setting in a negative feedback loop,” said JPMorgan's Roever.
Regulators including Fed Chairman Jerome Powell are seeking to reduce markets reliance on Libor due to the decline in loans backing the rate.
If the rate stops being published "that has all the potential of being a pretty significant financial stability problem," Powell said on Tuesday.
The tax overhaul is not the only factor impacting bank borrowing costs though.
A surge in U.S. Treasury borrowing concentrated in short-dated maturities, after Congress lifted the debt ceiling recently, has sent borrowing costs higher across fixed income and money markets.
Seasonal trends in Treasury bill issuance are seen as worsening the trend. The Treasury is expected to issue a large chunk of its bill issuance before April, when tax receipts typically reduce its funding needs. A large part of the recent uptick in supply has also been caused by its need to replenish its cash balance, which was depleted as lawmakers negotiated to increase the debt ceiling.
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