This Market Gauge Is Showing Rising ‘Brexit’ Fears

Worries over whether Great Britain will leave the European Union are showing up in unlikely pockets of the financial markets.

One of them is the difference between the London Interbank Offered Rate and the overnight indexed swap rate in the U.K. Measures of the gauge, known as the Libor-OIS spread, spiked prior to the financial crisis. Now, uncertainty about the impact of a “Brexit” are pushing the spread up in the U.K., according to TD Securities.

The UK will vote in June on whether to to stay in the European Union. With British voters divided on the decision, the possibility of an exit has become a flashpoint for financial markets across the world. Among the many unknown impacts of an exit: some financial firms could relocate, analysts say.

The concerns are showing up in this obscure but important spread. Libor is a benchmark that measures how much it costs for banks to lend to each other on a short-term basis. An overnight indexed swap exchanges an overnight rate for a fixed rate and is thought to be basically risk free. The difference, or spread, between the two is seen as one signal of bank strength and the financial sector’s willingness to lend. A rising spread indicates more stress in the financial system.

While most such Libor-OIS around the world have been stable, the U.K. spread has been steadily rising in recent weeks. That’s a sign of concern about what would happen to the U.K. financial system if the country voted to leave the EU.

“It hurts the UK banking system probably the most,” said Priya Misra, head of global rates strategy in New York at TD Securities.

The following chart shows the three-month Libor-OIS spreads in September 2016 and September 2017.

Photo: TD Securities

The vote has impacted financial markets in other ways as well. The British sterling, for example, has made sharp moves against the U.S. dollar in recent months. And there may already be impacts on the economy. Citigroup economists, led by Michael Saunders, said Friday that measures of the UK economy show “loss of momentum in the last month or two -– with rising uncertainty and risk aversion probably reinforced by Brexit uncertainty and weaker activity in financial services.”

The rise in the Libor-OIS spread is another sign those concerns hit directly at the heart of UK’s financial system.

 

Source: WSJ

 

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