Volatility is the Newest Normal, LIBOR Run Up

Treasuries rallied this week, with the 10 year yield dropping to a level not seen since early February. The flight to quality rally is connected to the sell off in equities as markets whipsawed up and down on the possibilities of a trade war with China (markets rallied on Monday on the perception that the tariffs are resulting in negotiations, but the ultimate uncertainty of the outcome and effects will continue to weigh on markets until more issues are resolved) and tech headlines (Facebook, Tesla issues). Tesla’s debt is getting attention as spreads are blowing out on their corporate issuance. Overall credit spreads have widened slightly in the last few months. Combined with short term indexes rising (LIBOR, Prime, Fed Funds), the cost of capital to corporations is increasing. Speaking of the indices, 3 month LIBOR is up 61 bps this year, a period where the Fed Funds rate only increased 25 bps. The 3 month LIBOR is the commonly used benchmark for trillions of dollars of corporate debt. LIBOR’s “disconnect” from the Fed can indicate stress in the credit markets as in 2007-2008. But the culprit here may be US fiscal policy. Short term treasury bond supply is up due to the US budget dynamics and tax cuts. Also, corporations are repatriating cash or using cash for stock bybacks and other uses. That cash was often held in short term instruments. There is less demand and increased supply and that may be driving LIBOR’s rise. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners