Tuesday, November 29, 2011

OIS spread - compare & contrast

The USD OIS (overnight index swap) spreads continue to stay elevated. The chart below shows the spread between the 2-year LIBOR swap (IR swap) and the 2-year OIS. This is the market expectation of 3-month LIBOR for the next two years vs. the market expectation for the interbank overnight rates for the next two years. The spread between the two is the market expectation for the next two years of premium on the 3-month loan rate vs. the overnight loan rate.

2-year OIS spread (2-year rate swap rate - 2-year OIS swap rate) (Bloomberg)

That means the market anticipates a prolonged tightness in dollar term funding even though the Fed is expected to keep the overnight rates near zero.  The next chart shows the current LIBOR curve vs. the OIS curve.  Without this premium for term funding, the two curves would be right on top of one another.  But we have OIS curve following the Fed's trajectory - overnight rates near zero for the next two years, while LIBOR is "not listening" to the Fed because of the term funding premium.

 LIBOR Curve vs. OIS Curve (Bloomberg)

In contrast, here are the same two curves in 2005 when "balance sheet usage" for term funding was not a concern.  Those were the good old days.

 LIBOR Curve vs. OIS Curve (Bloomberg) on 11/29/2005

Elevated OIS spread indicates banks' increasing fears of lending to each other for longer than overnight and is a good gauge of financial stress.

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