A Tale of Two Cities - New York vs. Frankfurt
Chart 1 shows the recent behavior of the 3-month interbank loan rates in U.S. dollars and euros. Both in dollar and euro terms, these interest rates began drifting up in the second half of April as the Greek, Portugal and Spain (GPS) sovereign debt challenges came to the fore. If GPS were to default on its sovereign debt, this would have an adverse impact on some European banks. These potential losses for European banks caused interbank lending to "tighten up," thereby driving up interbank loan rates. Although U.S. banks have much less direct exposure to GPS sovereign debt than do European banks, U.S banks have indirect exposure via their interbank lending to European banks. Hence, the interest rate on U.S. dollar interbank loans went up. Another reason the interest rate on U.S. dollar interbank loans increased was that European banks were scrambling to obtain U.S. dollar funding in addition to euro funding. Toward the end of May, the interest rate on 3-month dollar-based interbank loans leveled off, but the interest rate on 3-month euro-based interbank loans has continued to rise.
Chart 1
Why the divergence between the interest rates denominated in dollar vs. euros? Part of the explanation might have to do with the Fed's re-activation of dollar swap lines with major foreign central banks on May 9 and May 10. This alleviated some of the liquidity tightening being experienced by European banks with regard to their dollar funding needs. By re-activating its dollar swap lines, the Fed has indirectly helped alleviate liquidity pressures on U.S. banks as well as European banks.
The ECB has agreed to take Greek sovereign debt as collateral for short-term loans to euro-zone commercial banks regardless of the credit rating of this Greek debt. And this is good. But the ECB is discontinuing as of Thursday a 1-year maturity funding program for euro-zone banks. This has created anxiety among some Spanish banks. Although the ECB has said that 3-month funding will be abundant, some capital-challenged banks would prefer to lock-in funding for a year rather than having to refund four times a year. This is a factor putting upward pressure on term euro-based interbank loan rates.
It is interesting to me how the ECB's policy approach has shifted of late. Prior to the Lehman crisis, the ECB seemed to pay more attention to the behavior of monetary aggregates than other central banks. The ECB appeared to buy into the Friedman proposition that inflation is always and everywhere a monetary phenomenon. But for some reason, the ECB now appears worried that it might be pursuing too accommodative a monetary policy despite the fact that growth in euro-zone monetary aggregates is exceptionally weak (see Chart 2). Jean-Claude, lighten up. Renew the 1-year term funding.
Chart 2
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
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Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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