Interest Rates Diverge and Impact Trade Finance David Gustin - March 14, 2017 1:28 AM | Categories: Trade Credit Commentary | Tags: TED spread It’s timely to consider recent movements in both Libor and Treasuries given the recent noise around an upcoming Fed hike (the third in 10 years!). You see, so many trade loans are priced in Libor (or Euribor). Libor is the interbank funding rate, and recently has risen quite dramatically as the cost of bank funding has gone up. This is really a factor of some recent structural changes that have changed the fixed income landscape. The big change was when prime money market funds that do not invest solely in Government treasuries now have to mark their assets to market. Because of this, hundreds of billions left these funds. These funds traditionally invested in bank commercial paper. Now with a huge demand gone to buy bank paper, banks without access to non-brokered deposits and more diversified funding source need to go out to the interbank market, and hence are driving up the price of Libor. For short term investors, this is a good thing (yeah, finally a bit of yield). But not for banks, who must borrow in the interbank market. In addition, back in December, the Fed raised rates by 25bps. And the third way the Government impacted banks funding costs was an event that happened on 31 Dec 2016 and went little noticed. Basel III capital rules phased in another 50bps of equity cost. Now contrast Libor based assets to those of the U.S. Treasury market. Assets priced relative to treasuries have not seen the same rate increase. Why? The Federal Reserve, through their buying of long dated treasuries, has driven investors to search for other assets. And Banks, because of regulation, are now buying more short term treasuries. The result, lots of demand for the supply and hence rates have not risen like their Libor counterparts. Why this matters for trade finance is that billions of dollars of receivables are priced based on Libor. Libor’s importance is its use as a benchmark for many other interest rates at which business is actually pay. The chart below shows the divergence between (3 Month LIBOR / 3 Month Treasury Bill) as a measure of the perceived credit risk in the U.S. economy. As banks adjust to increased cost of funds, money will get more expensive for supply chain finance programs and other early pay finance driven off of LIBOR. This further opens the door to non banks that have significantly cheaper capital costs than banks to fund supply chain finance and other assets originated via corporate buy-sell transactions. Don't forget to sign up for TFMs weekly digest delivered to your inbox every Monday here Related Articles Discuss this: Cancel reply Your email address will not be published. Required fields are marked *Comment Name * Email * Website Notify me of new posts by email.