While Libor remains a vestige of a bygone world in which unsecured bank lending still mattered – which was made obsolete by $1.5 trillion in excess reserves sloshing around – traders are puzzled by the sharp move in 3M USD Libor this morning, which on Thursday morning was fixed lower by 4.063bp, falling from 2.73763% to 2.69700%.
This was the largest decline since May 2009. Libor fell to 2.69700% from 2.73763%.
While Libor is on its way out, set to be replaced by the Fed’s SOFR alternative, it is still a reference security for trillions in floating-rate debt, and more importantly, remains the primary way to bet on short-term interest rates via eurodollar futures, which settle into Libor, and according to Bloomberg, has 12.52 million contracts in open interest, vastly more than Fed Fund futures which have total positioning of only 1.8 million contracts (SOFR remains an experiment speck with just 85K futures after 9 months of existence).
As such today’s massive move has prompted lots of question, and no answers, seeking an answer for the violent move lower. Making matters worse, whereas previously there would at least be disclosure of LIBOR fixing by bank (which in the days leading up to the financial crisis would allow traders to discern which financial institution is suffering from liquidity shortage, and prompted further Libor manipulation by member banks), the current iteration no longer provides this level of transparency.
“That a key benchmark can exhibit such sudden volatility with no observable rationale” is a problem according to Bloomberg commentator Cameron Crise, although according to Nomura’s Charlie McElligott, “the move could be driven by an adjustment towards current 90d CP rates” as CP yields have been falling even as Libor has been relatively flat, prompting speculation that Libor has some catching down to CP.
In any case, the sharp drop in Libor appears to be powering today’s rally in US rates, even as Bloomberg notes that it “raises the thorny questions of how and why the rate fell so precipitously in one day” adding that it is not a bet on Fed policy as OIS rates have been stable.
Some have invited comparisons with the “jumpy” SOFR rate, which is far more volatile than Libor, which is “likely going to be viewed as a bug rather than a feature, but at least you know that the rate is fixed based on hundreds of billions of dollars of transactions.”
Yet the question in light of today’s sharp move is “what drives the Libor fixing?” As of this moment, nobody really knows.