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Opinion

Libor transition: Surge pricing

It was just what the regulators didn’t want: another surge in Sofr just as the timetable for transition away from US dollar Libor enters its critical phase.

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Benchmark surge: the perfect storm

When Euromoney was researching a feature in August on the market’s transition away from Libor, one portfolio manager was keen to impress upon us the importance of the fact that the US replacement rate (Sofr – secured overnight financing rate) is reliant on repo.

“The repo rate is very different from Libor,” he told us. “It solves the issue of having robust underlying market data, but it behaves differently to Libor and the market needs to learn how it behaves.

“There are spikes, but the Fed can introduce tools to reduce volatility such as a repo facility. The Fed is very much aware of this. But – in and of itself – Sofr will be more volatile.”

His words were still ringing in our ears on September 17, when the Sofr rate shot up from 2.43% to 5.25%.

Perfect storm

This ‘Sofr surge’ was the result of a perfect storm: an upcoming corporate tax payment date, the issuance of more than $100 billion-worth of investment-grade debt that had drained repo markets to fund inventories at the broker dealers, and $60 billion of Treasury bond maturities that had negatively impacted available cash.

The Fed had been unable to intervene to stabilize the overnight rate, which added to the problem.

These conditions, which had caused Sofr to move 282 basis points, had produced a mere 4bp move in overnight dollar Libor, a 1bp move in one-month US dollar Libor and a 2bp move in three-month US dollar Libor.

This is not just material in the world of interest-rate pricing, but of huge economic impact - Shearman & Sterling

It is not the first time this kind of spike has happened: on the last day of 2018, Sofr shot up 147% to an intraday peak of 7.25%.


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