By Dhara Ranasinghe and Yoruk Bahceli
LONDON (Reuters) – Financial indicators signaled increasing signs of stresses spreading through global markets on Friday as concerns grow over the wider economic fallout of Russia’s invasion of Ukraine.
With stock market prices and bond yields falling, gauges regarded as stress indicators are attracting investor attention.
The so-called FRA-OIS spread, which measures the gap between the US three-month forward rate agreement and the three-month overnight index swap rate, hit its highest level since May 2020.
A higher spread reflects rising interbank lending risk or banks hoarding US dollars, meaning that it is widely viewed as a proxy for banking sector risk.
The FRA-OIS spread rose to around 29.4 basis points on Friday, compared to 23.7 bps on Thursday.
Global alarm was triggered earlier by a blaze at the site of a Ukrainian nuclear power station, Europe’s biggest, after it was seized by Russian forces. The fire has been extinguished.
“The market’s liquidity conditions have weakened this week, and were exacerbated overnight after reports of shelling to Europe’s largest nuclear plant in Ukraine,” said ING currency strategist Francesco Pesole.
Scale, the FRA-OIS gap remains well below levels seen at the height of market turmoil in 2020.
“Dollar funding conditions are not too alarming at the moment, but the deterioration in the past week naturally argues in favor of a stronger dollar,” Pesole added.
The dollar index jumped nearly 1%, mainly at the expense of the euro which has tumbled 3% this week because of Europe’s exposure to the Russian economy.
The demand for dollars was reflected in swap markets where dollar borrowing costs rose further. Three-month euro-dollar swaps rose to around 25 bps, compared to 15 bps on Thursday.
Dollar-yen and dollar-pound swaps also tightened..
However, swap rates remained below a March 2020 peak of nearly 40 bps hit on Monday, and analysts said the Federal Reserve and other major central banks have mechanisms to relieve funding stress.
Swap and repo lines have been used since the global crisis and the Fed maintains standing FX swap lines with several central banks.
“We are in a world now where the emergency liquidity facility stand at the ready so there’s less of a fear about a scramble,” said Eric Theoret, global macro strategist at Manulife Investment Management.
Stress metrics are on the rise elsewhere too.
The cost of insuring exposure to a basket of “junk-rated” European company debt jumped 29 basis points to its highest since June 2020 at 388.2 bps, the iTraxx European Crossover index showed.
Another iTraxx index which measures the cost of insuring exposure to senior bonds from banks and other financial issuers rose 7 bps to 91.7 bps, a May 2020 high.
A European banking stocks index is down 16% this week, reeling from Western sanctions on Russia, a scaling back of interest rate hike forecasts and a growing macroeconomic environment.
“There’s just a sense of elevated risk premia across all markets,” said Helen Rodriguez, head of credit research EMEA at Mizuho.
“Inevitably there’s going to be a lot of trade-offs to be made between passing on those inflation pressures to consumers or manufacturers and that’s going to be a very tricky balance for companies to face and inevitably that’s starting to crystallize on people’s minds.”
Also in focus was the daily number of repo fails, which occur when a market participant is unable to deliver the security on time to complete a repo transaction.
Societe Generale said daily repo fails of Treasuries rose to $76.1 billion on Feb. 28, the highest since June 2020 and more than double the average for this year.
While repo fails are relatively common, large numbers of failures in volatile markets suggest dislocations and stress.
Similar concerns led Germany’s finance agency to increase a bond to ease scarcity in overnight lending markets.
The spread between interest rate swaps and German bond yields was at its widest since 2011 for 10-year debt, in a sign of the bond scarcity.
“We have all this liquidity but it still has the ability to disappear suddenly,” said Mike Kelly, head of global multi-asset at PineBridge Investments.
“It shows how skittish things are and we are not in normal times,” Kelly added.
(Reporting by Dhara Ranasinghe; Additional reporting by Saikat Chatterjee, Sujata Rao and Yoruk Bahceli; Editing by Sujata Rao and Alexander Smith)
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