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Net Net: Promoting innovation and managing change

Banks React to Central Bank Swap Rate Cut

Economists at major international banks are sounding off this morning on today's big announcementof a coordinated action by central banks  around the globe.

The reaction is mixed, if tilted toward the positive. The Royal Bank of Canada's rates strategist Michael Cloherty sees it as a positive although not a "game changer."

From the RBC note this morning (via MarketBeat

"The cost of borrowing from the currency swap lines was cut from OIS+100 [basis points] to OIS+50bps. In addition, the ECBhas cut the excess margin it was charging on these trades from 20 percent to 12 percent, so the all-in cost of borrowing for European banks will fall by more than 50bps.

This is effective as of Dec 7.

Note that it is now cheaper for foreign banks to borrow dollars from their local banks than it is for U.S. banks to borrow dollars from the [Federal Reserve] , so we could see a 25bp cut in the discount window in the coming days to level the playing field.

Again, we look at this facility as eliminating the liquidity element of LIBOR(banks don’t need to be as afraid of lending term because they know they have a backstop liquidity source that won’t be that expensive, which means the money market curve stays flatter) rather than thinking that LIBOR will move all the way to the new ceiling. So we think LIBOR can still creep a bit higher than spot, but it will be difficult to get higher than 60bp.

In addition, the other central banks are setting up bilateral lines (sterling for euros, etc) , although we don’t expect those facilities to be used in anywhere near the size of the dollar facilities so we don’t expect any significant impact.

This is a very big deal if you are trading Eurodollar contracts as the Fed was more aggressive (we thought they would go to OIS+75bps rather than OIS+50bps), but it doesn’t change any of the fundamental issues in Europe. The major help to risk assets is that those investors no longer will need to see LIBOR rise relentlessly (and it should make year-end a little less messy), but we don’t think this is a real game-changer."

The Royal Bank of Scotland sounded a similar note (via FT Alphaville):

The net read here is that this is a clear positive for market sentiment. At the time of writing 3m EUR/USD cross currency basis has tightened considerably (currently 23.5bp tighter since the move at -134bp) and front contract USD FRA/OIS has tightened by 10-12bp today. However, ultimately this is just a backstop and doesn’t fundamentally change the bigger picture. We intend to follow up later with a more detailed note.

Nomura, however, sounds more positive on the action (via FT Alphaville, again):

It’s always darkest before dawn and today’s coordinated move by central banks harks back to the crisis-fighting days of late 08. We are encouraged that the monetary authorities are indeed back on the case again working as a team. Global banks are obviously interconnected and thus given the USD funding tensions of late this global CB coordination is a sign that folks in the right places are “getting it.”

In short, the banks seem to be adopting our view that this could be a confidence improving measure but might not go far enough given the depth of the underlying problems in Europe.

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