London Calling: Libor Revisited and the Greenback

The biggest developments in the market and economy this week were the decline in the value of our greenback and the move higher in long term interest rates (10yr U.S. government bonds moved to 3.46%, a level not seen since last Fall).

Despite these concerns, many analysts will point to the drop in Libor (London interbank overnight rate) as an indication of the increased confidence in the global banking system. I strongly disagree.

I believe the drop in Libor is not a reflection of the “fundamental” improvement in our global banking system, but rather a “technical” reflection of the supply of dollars that have been injected into the global economy. There is an enormous difference in these lines of reasoning and the implications they have for our markets and economy going forward.

If Libor were declining because of a “fundamental” improvement in the global banking system, it would be reflected in an increased flow of credit into the economy. That flow is not happening.

If Libor is declining because of a “technical” supply of  dollars, then it would be reflected in a decline in the value of the dollar, an increase in long term interest rates, an increase in the prices of select commodities (gold has rebounded to $957/oz, oil is back above $60/barrel), and other inflation-related variables. Yes, we are seeing all of these developments.

Let’s revisit my post from May 15th, What Is Going On With Libor?

While many analysts were promoting the drop in Libor as a positive, I begged to differ and wrote:

Has the drop in Libor coincided with an improvement in the credit markets? No. Despite what pundits would tell you, credit spreads remain at elevated levels. In fact, on an inflation adjusted basis, rates are at the highest levels since the early 1980s.

Why aren’t banks lending as much? Lack of confidence in the economy along with enormous embedded losses in their current book of loans. Those losses are real and will be rising. The elusiveness of bank credit is highlighted in a McClatchy article, Businesses Struggle as Bank Loans Remain Elusive, in the Newsworthy section of Sense on Cents.

Thus, if a drop in Libor is not a reflection of improved credit conditions, what does it mean?

In my opinion, it is a precursor to a drop in the value of the dollar. Why?

Very simply, too many greenbacks floating around.  A decline in the value of the dollar is inflationary. Both core rates of producer prices and consumer prices reported this week were higher than expected. I’ll be watching.

Please recall, there are always three factors that determine the level of a market: fundamental, technical, psychological. A move in Libor is almost always analyzed from a fundamental standpoint. However, in our Uncle Sam economy, we need to be increasingly diligent in reviewing all three of the aforementioned factors along with the implications they have for our global markets as we navigate the economic landscape.

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

Visit: Sense On Cents

Be the first to comment

Leave a Reply

Your email address will not be published.