Bank Funding Crunch Deepens as Swap Rates Soar

Europe’s government debt crisis is starting to infect the bank funding system, driving borrowing costs higher from Asia to the U.S. and threatening to slow the global economic recovery, Bloomberg reports.

“At the moment, it feels worse than 2008. There is no buyer of risk in the market.”

Geraud Charpin

The interest rate that financial companies charge each other for three month loans in dollars is the highest since August, while traders are paying record amounts to hedge against losses in European bank bonds. Yields on all types of corporate bonds rose last week by the most relative to government debt since Lehman Brothers Holdings Inc.’s bankruptcy in September 2008, according to Bank of America Merrill Lynch indexes.

European Union finance ministers pledged to stop a sovereign debt crisis from shattering confidence in the euro as they held an emergency summit over the weekend to hammer out a lending mechanism for deficit-stricken nations. The sovereign debt crisis may end up costing governments more than $1 trillion, according to credit investment firm Aladdin Capital Holdings LLC in Stamford, Connecticut, with knock-on effects on banks and corporates.

“Whether the markets completely unravel depends on whether politicians can stabilize the peripheral government market,” said James Gledhill, who helps manage about 58 billion pounds ($85 billion) as head of fixed income at Henderson Global Investors Ltd. in London. “The tail risk is the stress on banks which stops them from lending to corporates and feeds through to become a real economy problem.”

Global corporate bond issuance plummeted last week, with $9.4 billion of debt sold, the least this year, following $30.1 billion in the previous five-day period and $47.9 billion in the week ended April 23, according to data compiled by Bloomberg. JPMorgan Chase & Co. said in a May 7 report that it’s taking off a recommendation that investors own a greater percentage of junk bonds than contained in benchmark indexes.

“Look for the de-risking that is underway to continue,” the New York-based bank’s fixed-income strategists including Srini Ramaswamy wrote. “Funding pressures have increased for European banks and could worsen over the near term, but are unlikely to deteriorate to the extent seen in 2008 that led to forced develeraging.”

The rate banks say they pay for three-month loans in dollars, known as the London interbank offered rate, or Libor, jumped 5.5 basis points to 0.428 percent on May 7. It climbed 8.2 basis points, or 0.082 percentage point, on the week, the biggest increase since October 2008.

The spread between three-month dollar Libor and the overnight indexed swap rate, a barometer of the reluctance of banks to lend known as the Libor-OIS spread, jumped to 18.1 basis points on May 7, three times the 6 basis-point spread on March 15 and the highest level since August.

“At the moment, it feels worse than 2008,” said Geraud Charpin, a fund manager at BlueBay Asset Management in London. “There is no buyer of risk in the market.”

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Filed under International Econnomic Politics, National Economic Politics