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.
The great Libor debate continues through 2008, with spreads to OIS as wide as ever. JPMorgan and Deutsche Bank – the leaders in US dollar and euro swaps respectively – have divergent views of the future for OIS, one possible replacement.
“We are seeing increased activity in long-dated OIS-based swaps and expect that part of the market will gravitate towards this as an alternative benchmark to Libor,” says Felson.