Friday, June 19, 2009

The Debts of the Spenders: Libor, (Euro)Dollar, and Gold

*UPDATE - Corrections made.

The war between deflationists and inflationists is finding a new battlefield in the LIBOR markets. LIBOR is the rate that banks charge each other for overnight or shorter term (typically dollar) loans. The Eurodollar futures contract as traded on the CME/CBOT is based off a 3 month Eurodollar $1 million deposit and are bets on which way the LIBOR's BBA (British Bankers Association) council will vote.*

A higher LIBOR is indicative of an aversion to risk taking and a higher, projected borrowing costs (e.g. higher interest rates). LIBOR is set by a council of member banks as determined by the BBA. Recently, the BBA has decided to open the LIBOR process to a bigger group of banks.

The other way to predict future interest rates is to look at the Fed Funds market (which is ALSO traded on CME/CBOT). But that market has its own problems. Fed funds options are still predicting - more or less - continued low interest rates. This Fed funds action flies in the face of recent bond market moves by the vigilantes who are either selling their long bond positions or short selling treasuries to drive yields higher.

Both markets have their (dis)advantages. Normally, the spread or difference between LIBOR and Fed Funds is not that great but when you start to see a widening then there is cause for potential alarm. And the greatest threat that sets the large banks would be a bond market dislocation where bonds are no longer considered a flight to safety.

So, the question is: where would the liquidity flow from and to? The answer is most certainly going to include an exit FROM equities, commodities, and fixed income (including treasuries). The next step is where deflationists and inflationists diverge. Deflationists believe that higher LIBOR would mean a flight to safety to the dollar and yen. Inflationists believe that the funds will go to precious metals. I have a strong deflationist bias myself. After all, paper currencies - for all their flaws - are liquid mediums of exchange. You can buy food and transportation w/paper money. The same cannot be said for gold bars.

*Trade Unit:
Eurodollar Time Deposit having a principal value of $1,000,000 with a three-month maturity.

Point Descriptions:
1 point = .01 = $25.00

Contract Listing:
Mar, Jun, Sep, Dec, Forty months in the March quarterly cycle, and the four nearest serial contract months.

Product Code:

Trading Venue: Floor

Hours: 7:20 a.m.-2:00 p.m.Holidays LTD(Monday 5:00 a.m.)

Minimum Fluctuation:
Regular 0.01=$25.00
Half Tick 0.005=$12.50
Quarter 0.0025=$6.25 for nearest expiring month.
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