By ETF Heat Map Team
The London Interbank Offered Rate (Libor) has gone up as the money market funds reforms resulted in reduced demand for short term debt. There is greater probability that the rate will stay elevated given market participants currently predict above even odds for FED to increase this year’s cost of borrowing. Furthermore, according to consensus survey of analysts by Bloomberg, the three month rate will remain close to 0.85% at the end of 2016 and 1.38% at the end of 2017. As such we preview the impact on the USD, Yuan and currency ETFs that might benefit investors.
The rapid increase in the US borrowing rate which is at its 7 year high (yet significantly lower than the last decade) is increasing the cost of billions that Chinese companies are currently servicing. This is further leading businesses to repay their foreign loans and while pressuring on the yuan to weaken. Increases in the Libor rate will prompt the business community in China to get more dollars to repay their overseas loans, and this will as a result also increase the outflow of funds to the US. A potential increase in depreciation pressure is expected to tighten funding conditions in China and directly impact the bond market there.
Certain ETFs to worth considering to react to this exchange rate trend include some of the following ETFs available in the ETF Heat Map database and screener:
- UUP – PowerShares DB US Dollar Index Bullish Fund
- ICI – iPath Optimized Currency Carry ETN
- CBON – VanEck Vectors ChinaAMC China Bond ETF
The Chinese businesses borrowed dollar loans are mainly based on the London Interbank Offered Rates (LIBOR). As LIBOR goes up, there is an increase in exchange rate pressure, according to Ming Ming, Citic Securities Company’s head of fixed income. The servicing of foreign debts has been one of the main causes of the weakening of the Yuan since the Chinese government brought down the value of their currency last August. From a high of $1.1 trillion in 2014, claims on China by global banks went down to $695 billion by the end of March, according to the Bank for International Settlements.
According to Citic’s Ming, the yuan rate has a more significant relationship with Libor than with its corresponding rate in China. In the past 12 months, the Yuan has depreciated by 4.9% against the dollar.
The possibility of Libor’s jump to prompt capital outflows from China is expected to generate an incidental effect in the bond market. An increase in funds moving out of the Chinese economy would reduce the likelihood for the People’s Bank of China to cut the standard interest rates and reserve requirements for banks.
Furthermore, the US employment data which is weaker than what was expected did not bring down the prospects of there being an interest rate hike later this year. This will further strengthen the U.S. dollar when the interest rate does move up. As such, we have quickly previewed certain ETFs (including currency ETFs) that market participants can add to their portfolio.