There are some signs of increased pressure within U.S. dollar funding markets as fears grow around the outlook for the banks and the turmoil drives lenders to shore up their own cash buffers.
With global financial markets reeling in the wake of Silicon Valley Bank’s bank-run-fueled failure last week, worries about the future of Credit Suisse have amped up global concern. That sent short-end debt-market rates plummeting again Wednesday as investors radically shifted their outlook for central bank policy and flocked to haven assets.
Dollars continue to flow through the pipes of the interbank lending system, but there are indications that the cost of funding is ticking up and that institutions are taking the precaution of building up their cash piles.
Rates on overnight repurchase agreements moved higher for a period on Wednesday, pointing to stronger demand and general jitteriness. And a number of other market indicators, including the gap between forward-rate agreements and overnight index swaps, are also indicating heightened tension. Activity around the Federal Home Loan Banks system in recent days is suggestive of banks looking to ensure they have enough cash. On top of that, stock prices for many lenders have been in free fall, posing potential risks.
“There’s a dislocation in the market,” said Scott Skyrm, executive vice president at Curvature Securities. “Cash gets pulled from one player in the market and goes to another and it eventually arrives in the market but in a different place.”
Smaller banks are among those potentially most directly in the firing line, with depositors at risk of shifting their cash away even though the U.S. government has implemented a new backstop regime, and that could be pushing them more toward money markets and other alternatives.
Here are some of the funding-market indicators to look at for signs of pressure.
The rate on repurchase agreements for U.S. dollars, a key funding market, moved higher Wednesday. The general collateral overnight repo rate first traded with a bid-ask spread of 4.67%/4.66%, according to ICAP. That compares with around 4.45% at the end of Tuesday.
“If we do start to see a broad based increase in repo rates that will get the market and perhaps the Fed more concerned about the overall health of the banking system,” BMO Capital Markets Strategist Ian Lyngen said in a phone interview.
The gap between direct forward-rate agreements and index-tied ones — often used as a measure of the difficulty banks have in getting access to funds — has swelled. It this week moved to levels last seen around the early stages of the Covid pandemic in 2020.
In Europe, the spread between forward measures of European interbank borrowing costs and comparable risk-free rates — a key gauge of risk in the sector — has also been leaping higher.
Cross-Currency Basis Swaps
The cost of swapping euros and yen for dollars, the world’s preferred currency in times of stress, has also surged.
Federal Home Loan Banks
The Federal Home Loan Banks system, which provides funding to commercial banks and other members via so-called advances, has been increasing the amount of funds it has on hand, suggesting that it has seen a dramatic uptick in demand for dollars. In an unusual move, the FHLBs on Monday raised an unprecedented $88.7 billion through floating-rate notes, followed by another $19 billion on Tuesday. It has also raised some $22.87 billion via term discount notes and has overnight funding on top of that, which reached $67.55 billion on Monday.
The total amount of advances to members, which is published quarterly, had already more than doubled to $819 billion last year as increased Fed interest rates helped put pressure on deposits and this latest episode may push them higher still.
Another sign of the FHLBs needing to filter more money to its members is in its apparent pullback from the fed funds market. It’s the biggest player in that market, a place it tends to park its extra cash, so a pullback in fed funds activity — as has been witnessed this week - is indicative of the FHLBs channeling more money to other places.
Official Backstop Facilities
One area that market participants will be keeping a keen eye on is the usage of various official backstop facilities from the Fed. U.S. authorities last weekend introduced a new backstop for banks that Fed officials said was big enough to protect the entire nation’s deposits, the Bank Term Funding Program. Borrowing from the emergency bank facility will be disclosed each Thursday in the Fed’s regular balance sheet update, but individual borrowers won’t be named for two years.
That facility is in addition to other avenues that banks have, including the Fed discount window, which is often said to carry a stigma for banks. At the end of 2022, balances at the window had already risen to the highest level since June 2020. Combined with an increase in U.S. banks’ borrowings through other channels, that suggested the deposit loss was accelerating. Demand did retreat after that, but there’s a chance usage has since rebounded on the back of bank strains.
There is also the Fed’s standing repo facility. That has only 16 major institutions as counterparties, though. And as those are mostly of lesser concern at the moment, it’s unlikely to be in focus for funding right now.
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