Financial indicators showed growing signs of strain in world markets on Friday as concern grew over the economic fallout from Russia’s invasion of Ukraine.
With stock prices and bond yields falling, widely viewed indicators of stress are attracting investors’ attention.
The so-called FRA-OIS spread, which measures the gap between three-month US interest rate swaps and the three-month interbank index swap rate, reached its highest level since May 2020.
A higher spread reflects increased risk for interbank lending or dollar accumulation by banks, which is seen as an indicator of sector risk.
The FRA-OIS spread rose to around 29.4 basis points on Friday, from 23.7 basis points on Thursday.
The world alarm was triggered by a fire at the site of a Ukrainian nuclear power plant, the largest in Europe, after being taken over by Russian forces. The fire has been extinguished.
“Market liquidity conditions have weakened this week, worsening overnight following reports of the bombing of Europe’s largest nuclear power plant in Ukraine”, said ING currency strategist Francesco Pesole.
Nonetheless, the FRA-OIS gap remains well below the levels seen at the height of the market turmoil in 2020.
“Dollar funding conditions aren’t too dire at the moment, but last week’s deterioration naturally argues for a stronger dollar.Pesole added.
The dollar index rose almost 1%, mainly at the expense of the euro, which has slumped 3% this week due to Europe’s exposure to the Russian economy.
The demand for dollars was reflected in swap markets, where dollar borrowing costs continued to rise. Three-month euro-dollar swaps rose around 25 basis points, up from 15 basis points on Thursday.
Dollar-yen and dollar-pound swaps also tightened. However, swap rates remained below the highest since March 2020 of almost 40 basis points, reached on Monday. Analysts affirmed that the Federal Reserve (Fed) and other large central banks have mechanisms to alleviate financing tensions.
Swap and repo lines have been used increasingly since the global financial crisis, and the Fed maintains permanent foreign exchange swap lines with several central banks.
“We are now in a world where emergency liquidity lines are ready, so there is less fear of a ruckussaid Eric Theoret, global macro strategist at Manulife Investment Management.
Other indicators
Tension indicators were also rising in other areas.
The cost of insuring exposure to a basket of European corporate debt rated “trash” soared 29 basis points to 388.2 basis points, its highest since June 2020, the iTraxx European Crossover Index showed.
Another iTraxx index that measures the cost of insuring senior bond exposure of banks and other financial issuers rose seven basis points to 91.7 basis points, a May 2020 high.
An index of European bank stocks is down 16% this week, reeling from Western sanctions on Russia, lower expectations for interest rate hikes and a deteriorating macroeconomic environment.
“There is a feeling of high risk premiums in all marketssaid Helen Rodriguez, head of credit research for EMEA at Mizuho.
“There will inevitably be a lot of tradeoffs between shifting those inflationary pressures to consumers or to manufacturers, and that’s going to be a very difficult balance for businesses to strike, and inevitably that’s starting to crystallize in people’s minds.” he added.
Also in the spotlight was the daily number of repo failures, which occur when an agent in the market fails to deliver security in time to complete a repo trade.
Societe Generale said daily failures in Treasury repos totaled $76.1 billion on February 28, the highest since June 2020 and more than double this year’s average.
Although repo failures are relatively common, a large number in volatile markets suggests dislocation and stress.
Similar concerns prompted Germany’s financial agency to raise a bond to ease shortages in overnight lending markets.
The spread between interest rate swaps and German bond yields was at its highest since 2011 for 10-year debt, in a sign of the bond shortage.
“We have all this liquidity, but it can still suddenly disappearsaid Mike Kelly, head of global multi-assets at PineBridge Investments. “It shows how nervous things are and that we are not in normal times”, he added.
Source: Gestion
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