Interest rate derivatives: Rates - a year in the market
How have the constituent parts of the interest rate derivatives market held up through the worst financial crisis in a generation? Total Derivatives provides a case-by-case study.
Over the past 12 months, central banks have become adept at providing liquidity to the markets when and where it is required. As a result, systemic risk is reduced relative to mid-2007, although a few under-capitalized banks have failed.
However inter-bank Libor and Euribor rates have remained stubbornly wide to central bank rates, despite aggressive action by the Federal Reserve, European Central Bank and Bank of England. This has undermined the monetary policy transmission mechanism and challenged clients’ trust in the stability of the Libor-based markets – around which the fixed-income derivatives industry is based.
Although the banks are developing new OTC markets – notably overnight index swaps (OIS) – to provide an alternative to Libor, the risk is that unwelcome additional uncertainty in Libor will drive clients away from derivatives and towards cash markets and exchange-traded products.