Making money on LIBOR fallback (4)

In my previous episodes on "Making money on LIBOR fallback", I focused on GBP data. For this fourth episode, 4 months after the ISDA consultation results, I will show figures in USD. The situation is not as clear in USD, due to the Fed Funds / SOFR change and the lack of liquidity in SOFR swaps. But at the same time, the spreads are larger and have moved more, and more value has been transferred.

The graphs below all refer to USD-LIBOR-3M and Fed Fund rates. I start with the historical data of LIBOR-3M and Fed Funds compounded setting in arrears. The data is provided in the graph below, with the X-axis indicating the LIBOR-3M fixing date. The data last point is end of December, corresponding to the last LIBOR for which we can compute the equivalent overnight compounding setting in arrears at the end of March.



The spread is indicated in red. We have also reported the running mean and median for two hypothesis on the look-back period: 10-year and 5-year. As a hypothesis for those numbers, we suppose that the discontinuation will be announced on 1-July-2021 (for an actual discontinuation on 1-Jan-2022). The 10-year period would start on 1-July-2011. The indicated figures represent the running average/median since that date up to the reported date.


As of end of March, the reported historical averages/medians are between 18 and 27 basis points. How does that compare to the (forward looking) spreads in the swap market? The second figure reports the comparison for 30-year tenor basis swaps (Fed Fund swaps). The figure reports the historical data (dark blue line), the ISDA announcement date (red vertical line) and my personal estimate of the adjustment spread. 

In the last 4 months, after the initial jump on the announcement date, the market has steadily decreased to the upper bound of my estimate. It seems to have stabilized there in the last month.

As can be seen from the first graph, the 10-year/5-year period and mean/median choices can have an almost 10 basis points impact. The impact is presented here on the LIBOR/ON spread. But the impact originate from the fallback related to the discontinuation of LIBOR. So the true impact is on LIBOR, which is now anchored to SOFR (Fed Fund in the graph). Even if you don't have Fed Fund/SOFR swaps in your books and only LIBOR swaps, this value transfer is impacting you.

How did you risk manage the 10 basis points movement in the last 4 months? How much did the movement cost you? How do you plan to risk manage the 10 basis points uncertainty left from the coming discontinuation? How much value is at risk in your existing books related to the forthcoming choices to be made by ISDA's Board and Benchmark Committee?


Previous and ensuing episodes:

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