There are serious signs of stress in the U.S. money markets. Commercial paper and LIBOR spreads have soared over the last couple of months to the highest levels since the 2008 financial crisis. The difference between LIBOR and OIS, a popular gauge of distress in the banking sector, has widened to 0.57% today from 0.10% just four months ago. The trillion dollar question is whether the stress is technical in nature, in which case short-term rates will eventually normalize, or is this spike in credit a harbinger of another banking catastrophe. The spread between LIBOR and OIS has widened. The first step to answering that question is to gain an understanding of the root causes of the problem. It all started in late 2016 with the SEC’s implementation of money market reform. The new rules made commercial paper (“CP”) and other credit-sensitive instruments held in institutional prime money market funds subject to being marked-to-market. Funds that held this type of paper could no long publish a fixed $1 net asset value and could therefore “break the buck”. Investment vehicles that held U.S. government paper were exempt from the rule. The result was a massive shift in demand away from CP toward government securities. According to JP Morgan, prime funds now own only 25% of the outstanding CP compared to 70% in Q1 of 2016. The reduction in demand from prime funds caused the yield spread between commercial paper and Treasury Bills widened from 0.30% to over 0.65% by Q4 of 2016. As commercial paper cheapened, the higher yield became attractive to other U.S. dollar investors who could hold non-government risk. One group that stepped up to take advantage of the opportunity was overseas U.S. corporations. These companies had billions of U.S. dollars stashed in their European subsidiaries to avoid higher U.S. tax rates. Earning an extra 0.50% on their cash relative to U.S. T-Bills was very appealing. Sure enough, as these companies began to buy CP, the spread to T-Bills contracted. By the middle of 2017, the spread collapsed back to around 0.20%. Then came tax reform. One of the key pillars of corporate tax reform was the elimination of the incentive for U.S. companies to hold cash overseas. Companies like Apple and Microsoft, with hundreds of billions of dollars parked in foreign subsidiaries, began to repatriate some of their cash. They could now use that money at home to fund corporate activity like paying dividends or share buybacks, rather than having to issue debt in the U.S. The data verifies this activity. Net issuance of domestic U.S. investment-grade corporate bonds so far in 2018 is running at a pace of around $86 billion, compared to $132 billion for the same period in 2017 (source: JP Morgan). Smaller overseas cash balances translates to less need for CP and other money market investments. The drop in demand for short-term securities from U.S. corporations has contributed to the widening of commercial paper spreads and other interest rates like LIBOR that are sensitive to changes in credit. Tax reform and repatriation, though, only tell half the story. Part of the blowout in rates is from an increase in T-Bill issuance. There is a seasonal acceleration in T-Bill issuance in February and March stemming from the fiscal deficit created by the timing of tax rebates and tax receipts. In addition, extra supply in Q1 came from the replenishment of reserves at the Treasury Department after the extension of the debt ceiling. The stock of T-Bills spiked by $240 billion in February alone. The increase in supply cheapened T-Bills relative to OIS (the Fed Funds rate). The knock-on effect was higher CP rates to “compete” with risk-free government securities. The supply and demand imbalances in the money market have all contributed to the widening of spreads like T-Bills/LIBOR, OIS/LIBOR and CP/T-Bills. The good news is that these forces are likely to abate. The supply picture will improve next month as the Treasury Department starts receiving tax payments on April 15. Corporate repatriation is a one-time event and will ultimately end once companies finish moving their cash around. The higher commercial paper rates will eventually draw in “crossover buyers” to take advantage of the higher rates. The optics of the spread widening are concerning, but current levels do not reflect the same type of bank funding stress witnessed during the financial crisis. The widening is technical in nature, not fundamental. It looks more like an opportunity than a threat.
Numbers for short - term unsecured corporate debt and Libor have surged over the past couple of years , reaching levels not seen since the 2008 financial crisis . Analysts are undecided whether this is a short - term phenomenon that has arisen for technical reasons or an indication of another banking meltdown to come .