Invesco's Corner Blogs on LIBOR
Invesco posted a blog entry recently entitled, "What's behind the recent rise in US dollar Libor? Written by Rob Corner, it explains, "US dollar Libor (London Interbank Offered Rate denominated in US dollars) spiked recently to its highest level in seven years. Typically, US dollar Libor jumps during times of market stress, and/or when the US Federal Reserve tightens monetary policy. However, Invesco Fixed Income believes the recent increase in Libor is due to neither of those circumstances.... We believe the recent rise is primarily a result of the decline in demand by prime money market funds for short-term unsecured money market instruments, such as bank certificates of deposit (CDs) and corporate commercial paper (CP). The decline in demand for CDs and CP is a result of the exodus of $420 billion out of prime money market funds over the last year, driven by looming money market fund reform, which is set to be fully implemented on Oct. 14. Additionally, prime money market fund managers' unwillingness to commit a lot of capital to these instruments with maturities beyond Oct. 14, 2016, has reinforced the supply-demand imbalance. Substantiating this point, the weighted average maturity (WAM) of all prime money market funds has declined to 21 days from 36 days just three months ago. We believe this is a major reason for the disproportionate rise in three-month and six-month US dollar Libor. The shift of assets out of prime money market funds is expected to continue through October, likely providing little reason for US dollar Libor to revert before then.... In our view, there are three types of investors who may stand to benefit from a rise in US dollar Libor: Retail investors in mutual fund products that are not subject to money market fund reform, specifically ultra-short bond funds. Some institutional investors that can invest in institutionally oriented solutions such as global money market funds and separately managed accounts.... Existing holders of US dollar Libor-based floating rate notes.... We believe the future path of US dollar Libor will likely depend on the supply of and demand for loanable funds to banks. Libor could remain elevated if prime money market fund assets persist at relatively low levels and banks struggle to find new sources of funding to replace the decline in prime money market fund assets. On the other hand, if banks can easily replace the lost funding and/or assets move back into prime money market funds, Libor could revert back to a new clearing level."
