Stress levels flashing red in funding markets after Brexit vote

[NEW YORK] Stress levels are flashing red in money markets after the UK votedto quit the European Union, raising the prospect that policy makers will act to ease market turmoil.

A gauge of where bank borrowing costs will be in the months ahead, known as the FRA/OIS spread, hit the most extreme level since 2012 on Friday in Asia as the referendum sapped investor appetite for risk and spurred concern some European banks will find it harder to fund themselves.

The pound plunged to its lowest in more than 30 years while demand for havens sent the yen past 100 per dollar for the first time since 2013 and Treasuries surged by the most in seven years.

"Equity futures, gold, UK bank and insurance stocks are all sounding off their market stress sirens, and the funding market will go into its usual precautionary mode," said Sean Keane, an Auckland-based analyst at Triple T Consulting and the former head of Asia-Pacific rates trading at Credit Suisse Group AG.

"We would expect the Bank of England to immediately add liquidity in extra size today, and the ECB will follow. USD swap lines with the Federal Reserve may be used, and other central banks will be on alert."

The three-month FRA/OIS spread widened to 0.31 percentage point, compared with 0.27 on Thursday. The measure indicates where traders expect the gap between the three-month dollar London interbank offered rate, or Libor, and the fed funds effective rate - dubbed Libor/OIS - will be in the future.

The dollar Libor/OIS spread was 0.246 percentage points on June 23.

Overnight index swaps, or OIS, give traders predictions on what the Federal Reserve's effective funds rate will average for the term of the swap. The central bank's target rate is set in a range of 0.25 per cent to 0.5 per cent and the effective was 0.38 per cent on Thursday.

Markets may also be better placed to weather the current storm after measures were introduced with that aim in the wake of the global financial crisis, Mr Keane said. Today's moves are still tame compared with what occurred in 2008, when the Libor/OIS spread peaked at 3.64 percentage points.

"Funding markets are very different from 2007/08 and the reliance on short-dated cash raising has been significantly reduced," through regulations promoted by the Basel Committee on Banking Supervision, Mr Keane said.

"In addition to this, all banks and regulated entities run a much less aggressive funding profile, with reduced asset and liability mismatches and reduced reliance on sub 90 day funding."

BLOOMBERG