Fed Hike Aftermath Series: Should you worry about widening Libor-OIS spread?

Over the past few days and weeks, the financial markets have focused extra attention on widening USD Libor-OIS spread, which basically means higher funding cost. You are not familiar with the Libor or Overnight Index Swap (OIS) take a look at this Bloomberg article that explains all,  https://www.bloomberg.com/news/articles/2018-03-09/why-it-matters-that-the-libor-ois-spread-is-widening-quicktake

This article is few weeks old, and if you are looking for the latest chart, here is another Bloomberg article, which is among others focusing on the spread https://www.bloomberg.com/news/articles/2018-03-20/libor-ois-blowout-has-citigroup-eyeing-more-negative-effects

Majority of the articles have been pointing to the fact that the spread has reached the highest level since 2009.

Should you be worried?

Well, you can be, if you have too much of dollar-denominated debt as the funding cost rises but don’t be too worried before considering some other factors,

• This spread shouldn’t be the sole focus or else you would miss some vital points. Here is a link to the 2-year U.S. Treasury yield which has also reached the highest level since 2008. https://www.investing.com/rates-bonds/u.s.-2-year-bond-yield#
• Here is a link to the U.S. 10-year yield, which has reached the highest level since 2013, https://www.investing.com/rates-bonds/u.s.-10-year-bond-yield#
• Here is a link to the 3-month USD Libor which has also reached the highest level since 2009. Do note that it has been rising since the Fed started to raise interest rates and it still remains far below the level seen in 2007. https://fred.stlouisfed.org/series/USD3MTD156N
• Here is a link to the Federal funds rate, which also reached the highest level since 2009 and likely to go higher with the Fed projecting three more hikes in 2018. https://fred.stlouisfed.org/series/FEDFUNDS

You can see, it not sudden and it’s not new and it’s not an unexpected one. The cost of U.S. dollar funding has been growing for quite some time now.

So, should you be worried?

Interest rate increase during the expansion cycle is something that has happened for decades and centuries. There is no reason to worry if you don’t have excessive dollar debt or your business model has become too much dependent on the lower cost of funding after the Great Recession of 2008/09. Here is a link to the TED spread, which is the difference between 3-month Libor and 3-month Treasury and measures the extra interest demanded by investors for holding riskier debt, which clearly shows that the market is not overly worried on interest rate increase. https://fred.stlouisfed.org/series/TEDRATE

Nevertheless, it is important to use caution when taking up investment decision.  We expect the impact of the increased dollar funding cost to impact emerging markets dearly.