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HowCouldECB-FedDivergenceAffectLIBOR?
December28,201511:45AM
ByZ aneBrown
557Views
Here’salookathowthebenchmarklendingratemightrespondtothedifferingpolicypathsofU.S.
andEuropeancentralbanks.
How can we expect LIBOR—more f ormally, the London Interbank
Of f ered Rate—to react if the European Central bank (ECB) is
aggressively easing its monetary policy while the U.S. Federal
Reserve(Fed)doestheopposite?
LIBORistheratebankschargeeachotherf oreurodollarsintheLondoninterbankmarket,
not dissimilar to the f ed f unds rate that U.S. banks charge each other f or overnight U.S.
deposits. Eurodollars are U.S. dollar-denominated deposits at f oreign banks. The bank
loansinwhichmanyU.S.f loating-ratemutualf undsinvestaregenerallybasedonLIBOR.
Because eurodollars can act in many respects as a substitute f or f ed f unds, it is not
surprisingthattherateoneurodollardeposits,orLIBOR,closelytracksthef edf undsrate.
ExpectLIBORtocontinuetotrackf edf undsmovements,justasithassoconsistentlyover
thepastdecade,asshowninChart1.
Chart1.LIBORHistoricallyHasHewedCloselytotheFedFundsRate
Fed funds, overnight and three-month LIBOR, and prime rates, December 11, 2005–
December11,2015
Source:FederalReserveBankofSt.Louis.
The slight divergence between f ed f unds and overnight LIBOR in 2008–09 represents a
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higherLIBORrateinthewakeof thecollapseof BearStearnsandLehmanBrothers,when
banks became more hesitant to lend to each other. Since resolution of those dif f iculties,
LIBOR and f ed f unds have returned to their more normal, close relationship. Three-month
LIBOR shows slightly more volatility than overnight LIBOR, but still, as mentioned, closely
tracksthemovementof f edf unds.
Purchases by the ECB of short-term euro-denominated securities will not have a direct
impactonLIBOR.However,thenegativeratesonshort-termeuro-denominatedsecurities
created by the ECB’s quantitative easing program are likely to increase demand f or similar
maturity,dollar-denominatedinvestmentsastheFedraisesrates.
ZaneBrownisaLordAbbettPartnerandFixedIncomeStrategist.
Thevalueof aninvestmentinf ixed-incomesecuritieswillchangeasinterestratesf luctuate
and in response to market movements.As interest rates f all, the prices of debt securities
tendtorise.Asratesrise,pricestendtof all.
The fed funds rate is the interest rate at which a depository institution lends immediately
available f unds (balances at the Federal Reserve) to another depository institution
overnight.
LIBOR is an interest rate at which banks can borrow f unds, in marketable size, f rom other
banks in the London interbank market. The LIBOR is f ixed on a daily basis by the British
Bankers' Association. The LIBOR is derived f rom a f iltered average of the world's most
creditworthybanks'interbankdepositratesf orlargerloanswithmaturitiesbetweenovernight
andonef ullyear.
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