June- Pete Yorn
It's another I could trust you,
It's another thing to swear,
I'm ok with all the others,
It's just her I cannot stand,
I'm old enough to feel the way I do
And I know that you are true,
it's just a part of my genes.
Suspend your disbelief about long rates for a few seconds and let's see what's going on in June. The Eurodollar contract for June has gone from a sketchy 99.12 (88 libor) in November to 99.59/60 (41-40 set) on Friday. The last 5 sessions alone have erased all the stress of Feb. The scrutiny of the sets with the expanding (Tibor centered) fraud probe makes for plenty of conspiracy fodder. The more narrow focus of this note is to simply ask the question: 40bp?
As background, we have pointed to the acceptance of 3 month LIBOR as 12-14 over Fed Funds as one of the main causes of the credit bubble and its destruction. Throw in a Fed Chairman who tells everyone the date, time and change of the FF rate and you get higher rates, an inverted curve and - most dangerously - no reduction in credit. Boom. Jump ahead to today and 2 major changes stick out. Financial reform is proceeding in an amorphous but steady direction. The faith based, interbank counter party system has been replaced by a securitized and collateralized Central Bank counter party system.
I suggested the "back of the envelope" new equilibrium level for LIBOR was 45-55bp in early 2010 with FF between 12 and 25. Prior to the Japan disaster, rate sets had begun to hang around the upper estimate. Interestingly, as Europe imploded in the second half of 2011, 58bp again emerged as the high water mark set. (we are limiting this to dollars at this point) So, with the Biblical amount of monetary flood sloshing through the system, the reluctance to ever let anything like loss recognition take place, and an international fraud investigation, Lie-bor (a term I coined in 2008) is actually closer to reality than its been in years.
Repurchase Agreement general collateral, T Bills and the Fed Funds effective rates should become a more dynamic topic in Q2 2012. The ZIRP is after all, a range. At roughly 30 over FF "modern LIBOR" seems a tad optimistic sub-40. Sets in the hallucinatory areas of the low 20s would only convince us that the system had been nationalized and a "return to Oz" was being created over dealing with the harsh realities of the post credit super cycle landscape. Keep an eye out for June.