"Because US dollar (USD) LIBOR is used in such a large volume and broad range of financial products and contracts, the risks surrounding it pose a potential threat to the safety and soundness of individual financial institutions, and to U.S. financial stability." (Federal Reserve Alternative Reference Rates Committee, “Interim Report and Consultation,” May 2016.)
At the June 21, 2016, Roundtable on the Interim Report of the Alternative Reference Rates Committee, Fed Governor Jerome Powell referenced a $300 trillion number as the worldwide total of instruments tied to LIBOR. Powell’s remarks are available here. We thank Peter Boockvar for sending us the link to Powell’s comments.
If Powell is correct, the numbers we used in our estimates on LIBOR are only one-tenth of the full impact of rising rates. Our recent commentary is available here.
Here are some bullets.
1. The Fed will certainly be talking about LIBOR at Jackson Hole. Will Yellen mention it? We will soon find out.
2. So far the LIBOR-related rate structure is impacting the entire private sector, but it is not impacting the Treasury bill sector since the demand for HQLA is intensifying.
3. For the private sector this money market rule change is having the same impact on worldwide finance, in terms of US dollars, as a Fed rate hike of a quarter point would have had.
4. Remember that the LIBOR rise isn't over, and its intensity grows as we approach the mid-October implementation of the new money market fund rules.
5. We estimate the additional LIBOR intensification will work as if the Fed had instituted a second quarter-point hike.
6. Thus private-sector finance is facing the effects of back-to-back Fed hikes even as the Fed has done and continues to do nothing but talk. That is the power of a rule change as we described it on Tuesday.
7. There is complacency in markets today because market agents think post-October rates will reverse this intensity such that its effect proves temporary. They may be right. But they may also be wrong.
8. We think there are risks in LIBOR and widening LIBOR-related spreads because those spreads are going to be determined by the new rules, which are dramatically widening the gap between 100% HQLA and non-100% HQLA.
Doug Cass is often quoted saying “Risk happens fast.” We agree.
We remain defensive in our bond portfolios. We have a cash reserve in stock ETF portfolios.
And we are watching the shrinkage of the hedge fund asset class as investors get fed up with lockouts, high fees, and poor performance. So a liquidation pressure is at work in the markets. The opacity of the hedge funds makes it impossible to see the pressure points. The worst culprits are the funds of funds, or feeder funds.
At Cumberland we want to preserve capital for our clients. That is the driving force as we navigate the next two months.