Bank cost of funds versus mortgage prices

Eurodollar or LIBOR cost of funds is a common phrase in banking, what does it mean or do though?

Banks borrow short term and lend out long term, they call it ‘maturity transformation’ and in doing so they aim to make a mark up on the money, it’s the same concept that a shop uses in selling cartons of milk, fundamentally the idea is the same.

The LIBOR rate is ‘London interbank offer rate’ and represents the cost of funds for a high quality non-governmental institutional borrower.

To get an idea of the cost of funds (and this is currently speculative because Irish banks don’t get offered funds at Euribor [euro equivalent of Libor]) all you have to do is a simple calculation.

We know that banks tend to use three month money and that means that any calculation will always have the interest rate reduced by multiplying it by 90/360 (3 months = 90 days, and 360 = 1 year [I know that in real life 1 year is 365 days but that small change of 5 days gives …

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The yield curve on US Treasuries

Tom Keene from Bloomberg talks about the yield curve and some of the spreads that we are seeing in the current market, as well as that there are the seeds of the inflation story that we have been warning about since 2008.

Separately there are Harvard economists saying we need to see some inflation as it would prevent people from holding off on spending (look up the paradox of thrift and of deleveraging).

One final video worth looking at is the last one in this post, it poses the question ‘what will happen when the Chinese stop saving’.

One of the major oversights in this clip is that the Asian tendency towards savings is embedded in their culture, that means you can’t provide healthcare or anything else and expect the trend to end, it will probably take more than a decade for such a transition to occur because habits don’t change overnight, the ‘Chinese Way’ is not a movement that can turn on a dime.

The focus on trade links however is really interesting and the big …

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‘Pop’ goes the Treasury

Chancellor of the Exchequer Alistair Darling announced the UK budget yesterday, and it was revealed that the UK would have to issue more debt (Gilts) in order to continue with their present plans, the debt levels will rise to a record level of 79% of GDP by 2013/14. The period of 2009/10 will see £220bn of gilts issued, a full 20% greater than expected, on one hand this might be the ‘shock and awe’ approach, on the other it is extremely inflationary and has had an instant effect on GBP long term interest rates.

Several factors fed into this, yesterday the Public Sector net cash requirement was forecast at £16.5bn but the actual requirement was £28.4bn. Two lessons that countries around the world will learn from the current financial crisis are firstly – the need for counter cyclical planning, the second is the extreme danger that a country is put in by having a bloated public sector. Britain is also facing deflation.

Sterling is likely in for some secular …

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'Pop' goes the Treasury

Chancellor of the Exchequer Alistair Darling announced the UK budget yesterday, and it was revealed that the UK would have to issue more debt (Gilts) in order to continue with their present plans, the debt levels will rise to a record level of 79% of GDP by 2013/14. The period of 2009/10 will see £220bn of gilts issued, a full 20% greater than expected, on one hand this might be the ‘shock and awe’ approach, on the other it is extremely inflationary and has had an instant effect on GBP long term interest rates.

Several factors fed into this, yesterday the Public Sector net cash requirement was forecast at £16.5bn but the actual requirement was £28.4bn. Two lessons that countries around the world will learn from the current financial crisis are firstly – the need for counter cyclical planning, the second is the extreme danger that a country is put in by having a bloated public sector. Britain is also facing deflation.

Sterling is likely in for some secular …

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A look at Euribor, GBP Libor, and Libor

The graph below shows that despite different base rates in the US, UK, and Europe that our general interbank lending rates are correlated.

One of the issues the US has been struggling with is to get their long term rates down and you can see in the 5-7 year money range (I don’t have the 10yr TNote figures to hand), the idea is to get lending kick-started again, credit flowing is healthy, just not at the bubble levels. The 5yr figure is significant for personal lending and financing away from credit cards via personal facilities.

On the GBP Libor and Euribor the two yield curves are roughly matched so despite the UK having a base rate which is a full 75bips less than the ECB base they are still trading at higher margins. This is down to historic money pricing in the UK and it shows that Europe is truly pursuing a ‘middle of the road’ approach to rates, while the media focus is purely on the base rate …

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