Investors are zeroing in on key parts of the market for short-term borrowing to determine how higher costs are putting the squeeze on the banking system.
(Bloomberg) — Investors are zeroing in on key parts of the market for short-term borrowing to determine how higher costs are putting the squeeze on the banking system.
With some of the world’s largest financial institutions about to report on their third-quarter performance, funding markets show that banks are starting to pay up to protect their cash holdings from sinking and to safeguard against future runs on deposits. Banks have seen depositors flee in favor of higher-yielding alternatives, such as Treasury bills and money-market mutual funds, and this stress can be seen in the gap between rates for bills and commercial paper compared with those on swaps tracking Fed rate expectations.
The banking system has been under a microscope in the wake of turmoil earlier this year that resulted in the collapse of institutions like California’s Silicon Valley Bank and New York’s Signature Bank, and the large shifts in depositor cash that still threaten to erode confidence in the system in the high interest-rate environment. But while funding markets are hardly on the verge of imploding, investors are keeping a close eye on them as banks begin reporting on Friday. JPMorgan Chase & Co. and Citigroup Inc. are among the first out the gate.
“These gauges give us a sense of health of front-end and bank funding markets as to whether the recent rise and widening in spreads is a cost of funding issue or an availability of funding problem,” said Gennadiy Goldberg, head of US interest rates strategy at TD Securities. “At the moment, it appears to be a cost of funding issue rather than an availability of funding.”
Here’s what to look at for potential signs of strains and areas to be contemplating for possible knock-on effects.
Treasury Bill-OIS Spread
Setting the tone is the spread between the yield on three-month Treasury bills and overnight index swaps. The gap between these rates is widening, suggesting that investors are demanding more compensation to buy into the deluge of bill supply from the US government. That’s putting pressure on short-term borrowing rates across the board — including for banks.
Commercial Paper-OIS Spread
This spillover from the Treasury bill market is already seeping into commercial paper — corporate issuance of short-term IOUs that banks use to fill their coffers. In fact, there has been similar widening between rates on three-month financial CP and OIS. This spread is primed to continue expanding as long as banks are still losing deposits and need to replace departing dollars with other sources of funding. Bank of America Corp. strategists expect funding levels to rise as borrowing activity continues.
Federal Home Loan Bank Advances
The Federal Home Loan Banks provide funding to commercial banks and other members via so-called advances. These tend to be short-term loans secured by mortgages or other assets. In the wake of the banking system turmoil in March, total advances outstanding at the end of the first quarter surged to a record above $1 trillion as institutions clamored for precautionary funding to shore up their liquidity. Advances have retreated since then, though they’re likely to start increasing if banks need to bolster their cash.
Bank Term Funding Program
Following the collapse of lenders, the central bank in March introduced the Bank Term Funding Program, which offers one-year loans to institutions under easier terms than it typically provides, with the aim of preventing a firesale of government debt to obtain funding. Usage of the BTFP has stabilized around $108 billion over the past two months, though demand could pick up amid the latest surge in interest rates and rising bank funding pressure.
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