“We haven’t seen anything like this since the GFC.”
That was the first thing I thought when I returned to work after the Easter long weekend.
While markets have been focussed on tariffs, trade and protectionism, along with geopolitics, there are some potentially concerning signals emanating from deep in the financial market’s plumbing.
Short-term credit market rates have moved to their highest levels in some time and their “spread” to risk-free cash rates have widened. This issue may have originated in the US market, but we have seen similar phenomena in Australian and New Zealand short-term markets.
In turn, financial stress in Australia – as measured by the Financial Stress Index – has recently risen at its fastest pace since 2008 as a result of a spike in bank bill swap rate, or BBSW, and volatility on the stockmarket and foreign exchange markets.
While the index levels remain (just) below 2016 when China and oil concerns dominated markets, the pace at which it has spiked suggests we could soon be at levels of financial stress not seen since the global financial crisis. That may sound a little strange given the world feels far less stressed than back then. Hence, it’s worth monitoring.
This rise in the financial stress index shows that the recent tightening in financial market conditions is already impacting the Australian economy. As our chief economist Bill Evans recently noted, one small bank recently raised its variable mortgage rate to reflect the increase in funding costs. The fact that this is happening at a time when domestic housing has peaked, global growth appears to have plateaued and trade tensions are rising, adds to the case for Reserve Bank of Australia to continue keeping the official cash rate on hold.
And as a trade sensitive bellwether currency, there are downside risks to the Australian dollar.
There are many plausible explanations for the widening in the “US Libor-OIS” spread, a key gauge of credit risk and sentiment globally. There’s the rising supply of US treasuries, or bonds, to help fund the corporate tax rate reduction and the suspension of the debt ceiling in February. That’s driving a repatriation of corporate cash back to the US and in turn reducing the level of cash available for other bonds, leading to upward pressure.
Finally, there’s an impact from the end of month and quarter “squeeze” as money managers adjust their portfolios.
It is that last point that perhaps caused the most concern domestically. Given the other factors are mainly US-centric, many in the market were looking for a normalisation post-March 31. The fact this did not happen caused a fair degree of consternation.
The RBA commented on the ructions in wholesale debt funding markets in their last week, acknowledging that while “higher money market spreads have typically been an indicator of market stress”, the recent spike “does not relate to major market stress or concerns about bank credit risk”.
Nevertheless, the fact that such widening was last associated with the depths of the financial crisis (when banks globally did face funding risks) is unsettling.
In January, UK construction giant Carillion collapsed under a heavy debt load, providing a fresh reminder of what happened on numerous similar occasions during the GFC. While corporate gearing levels have decreased at an aggregate level, greater volatility in credit markets may be unnerving for the more leveraged firms.
In Australia, if our financial stress index remains elevated, markets could remain unsettled. Most business borrowers will be affected by the recent increase in the BBSW and may have considered their hedging options. Business credit growth had already stalled in the past three months, at just 0.4 per cent annualised growth, in contrast to a 3.2 per cent increase in 2017.
If funding costs continue to trend higher, we may be in for a bumpy 2018.
This article is general commentary and is not intended as financial advice and should not be relied upon as such.