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The LIBOR Limbo |
November 23, 2009
LIBORATED.com has reported the succession of record LIBOR lows during 2009. Three-Month LIBOR in US Dollars and Euros has set a string of new records. Three-Month Sterling LIBOR has trended higher in the fall. Movements for all three LIBOR rates have resulted from the same factor: the actions, actual or anticipated, of the respective currencies’ central banks.
As LIBORATED.com has stated in its news features, financial institutions have approved of central banks’ aggressive measures to bolster their countries’ economies (and as we know, we are really dealing with one big economy). These measures have included lowering central bank rates and putting cash into the system through programs such as the Bank of England’s Quantitative Easing (QE). Going back to Sterling LIBOR’s rise, as banks in the UK were expecting the end of the jolly good QE, their disquiet translated into higher interbank lending rates, a typical response when banks see trends they don’t like. Hence, Sterling LIBOR went up. More recently, a dour report showed the British economy was still contracting. Consequently, BoE will not stop priming the pump just yet.
Bad economic news in the colonies will have a similar effect on central bank policy. American unemployment has just risen to over 10%, the worst mark in nearly 30 years. The Federal Reserve has been in the midst of heavy economic interventions, including setting the Fed Funds rate at close to 0%. (No word yet if it is theoretically possible to have a negative Fed Funds rate—check back around the 2012 election.)
The Federal Open Market Committee, part of the Federal Reserve, sets the Fed Funds rate as a means of controlling the money supply. A lower rate means it is cheaper to borrow money, an intended chain reaction stemming from banks lending their Federal Reserve deposits to each other overnight at the lowered Fed Funds. Notice we said “cheaper” not “easier” since loans farther down the financial food chain have been less forthcoming for many borrowers, with banks accused of hoarding the capital Uncle Sam graciously provided after the credit freeze of late 2008.
Banks like low central bank rates. Banks like liquidity programs such as the BoE’s QE in the UK (not to be confused with John Mellencamp’s “R-O-C-K in the U-S-A.”) When economies stall or backslide, when unemployment climbs, central banks are supposed to drop rates and infuse cash. Double-digit joblessness, with no threat of inflation in sight, means the US Federal Reserve will keep the Fed Funds rate at or near rock bottom for the foreseeable future—until at least 2011, according to John Brynjolfsson, chief investment officer of Armored Wolf LLC.
According to data compiled from The Federal Reserve Board, The US Labor Board, and The Federal Reserve Bank of New York, there has been an historic delay of six to twenty months between the unemployment rate peaking and a Fed rate hike. The gap was twenty months amid the recession of the early 1990s and twelve months beyond the jobless peak following 9/11. So watch the unemployment numbers, wait for a sustained decline (it’s still going the other way), then start counting down for the Fed to raise rates. Given our current recession’s severity and markets’ hyper-jitteriness, the Fed is more likely to act on the long-end of its proven delay cycle, adding weight to the predictions of 2011.
As for the LIBOR Limbo: “How low can it go?” With Three-Month US Dollar LIBOR at recent marks of approximately 0.275%, the question is almost academic. Like the Fed Funds rate, US Dollar LIBOR is at an historic low and any further declines would have little additional effect. The more appropriate question: “How long will it stay low?” Answer: as long as the Federal Reserve keeps its rates low, which is bound to be awhile. At press time, the Dow has broken 10,000, but with unemployment breaking 10%, deep confidence and real recovery are not at hand.
The economy still needs to be tested for its own strength after the Federal Government finally weans it from massive amounts of stimulus programs such as TARP and HAMP. Once the economy appears to be standing on its own two feet, the government MUST directly raise taxes directly on the so-called “rich” and indirectly on the middle class to lower the deficit. Notice we did not say “to balance the budget.” Once the economy has passed these two very large tests, the Fed can then raise rates. 2011 may even be too soon. When the rate increases come, it is probable that they will be slow and mild knowing that a sequel to the Great Depression was barely avoided. The two wild cards that can affect a slow increase: The US economy has proven to be very resilient and could “overheat;” the Fed could be motivated to inflate its way out of a massive deficit buildup.
Meanwhile, the economy is in limbo as LIBOR does its own limbo, showing how low it can go.