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Staring at the Abyss of a Credit Crunch

(Bloomberg) A key gauge of banking-sector risk is indicating stress in dollar funding markets as equities around the world tank on growing virus concerns and traders bet on further central bank easing.

The FRA/OIS spread, a U.S. money-market benchmark that measures the difference in rates between forward-rate agreements and overnight index swaps, soared to the highest level since the funding upheaval seen back in September. That may be an indication of growing interbank risk or dollar hoarding behavior. At one point on Friday it widened to as much as 51 basis points, double its level from last week. It pared its move to around 43 after 3-month dollar Libor dropped more than 10 basis points, but is still up dramatically on the week.

“We are on high alert for any spill-over not just into funding today but credit markets,” NatWest strategists led by John Briggs wrote in a note to clients. “We are concerned that there are skeletons out there in closets we may not be aware of that come out in times like this, particularly leverage from the shadow banking system.”

The move came as the rally in global bonds gathered steam, with Treasury yields plummeting to record lows amid growing concern about the coronavirus. The number of cases globally approached 100,000 as more infections were reported in the U.S., Germany, France and South Korea.

Stresses are also evident in other parts of money and credit markets:

In front-end swap spreads, the two-year sector reached the widest level in over a yearIn cross-currency basis, three-month yen basis hit the widest levels of the yearEuribor futures fell and the FRA/OIS measure for euros also widened to a level unseen since SeptemberWidening of comparable measures also seen in other markets such as Australia

“We are staring at the abyss of a credit crunch,” said Kaspar Hense, a portfolio manager at BlueBay Asset Management, noting in particular the widening of dollar FRA/OIS.

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