By J.P. Morgan Asset Management via Iris.xyz
- One of the most important interest rates in global financial markets, U.S. LIBOR, has spiked causing some investors to fear that there is a fundamental problem with the global interest rate market.
- Rather than rising on fundamental forces, the rise in LIBOR can be attributed to technical factors, including tightening U.S. monetary policy, repatriated overseas corporate profits and increased debt issuance from the U.S. Treasury.
- LIBOR may seem like a small cog in the financial machine, but the recent rise has potentially wide-ranging implications for investors if not addressed.
- Rising LIBOR has three important effects on investor portfolios: shifting cash allocations, potentially rising U.S. rates and increased opportunities in global fixed income.
What is LIBOR and why does it matter?
LIBOR stands for “London Inter-bank Overnight Rate,” and it is defined as the cost of short-term borrowing between banks. Despite its name, the benchmark series is global in nature with LIBOR quoted in five currencies1 and serves as an important short-term fixed income benchmark with approximately $350 trillion worth of contracts globally trading off it, over 3 times greater than the total market cap of global equities2 .
As such, it is often a closely watched barometer of the financial health of the banking system – if LIBOR rates begin to rise, it can be a sign of financial stress. LIBOR also matters for mortgage repayments in the U.S. with $1.2 trillion of these adjustable rate mortgages tied to the benchmark, roughly 11% of outstanding housing debt.
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