How Many Trillions In Debt Are Linked To Soaring LIBOR?

Over the past month as Libor continued its relentless upward creep and is now higher for 37 consecutive sessions, the longest streak of advances since November 2005, and rising to 2.3118% while blowing out the Libor-OIS spread to a crisis-like 59bps, a cottage industry has developed to explain what is behind the dramatic move in Libor, and which – as we noted 2 weeks ago – can be roughly summarized as follows:

an increase in short-term bond (T-bill) issuance

rising outflow pressures on dollar deposits in the US owing to rising short-term rates

repatriation to cope with US Tax Cuts and Jobs Act (TCJA) and new trade policies, and concerns on dollar liquidity outside the US

risk premium for uncertainty of US monetary policy

recently elevated credit spreads (CDS) of banks

demand for funds in preparation for market stress

To be sure, we have commented extensively on what may (or may not) be behind the Libor blow out: if as many claim, the move is a benign technicality and a temporary imbalance in money market supply and demand, largely a function of tax reform (including the Base Erosion Anti-Abuse Tax) or alternatively of the $300BN surge in T-Bill supply in the past month, the Libor move should start fading. If it doesn’t, it will be time to get nervous.

But no matter what the reason is behind the Libor move, the reality is that financial conditions are far tighter as a result of the sharp move higher in short-term rates in general, and Libor in particular, which for at least a few more years, remains the benchmark rate referenced by trillions in fixed income instruments.

Which brings us to a logical follow-up question: ignoring the reasons behind the move, how does a higher Libor rate spread throughout the financial system, and related to that, how much national debt is at risk of paying far higher interest expense if only temporarily, resulting in even tighter financial conditions.

For the answer, we look at the various ways that Libor, and short-term rates in general “channel” into the economy. Here, as JPMorgan explains, the key driver is and always has been monetary policy, which controls short-term interest rates, and those affect the economy via several channels. Below we list those channels along with a brief description: