Almost Daily Grant's December 15th 2021
Comment of the Day

December 17 2021

Commentary by Eoin Treacy

Almost Daily Grant's December 15th 2021

Thanks to a subscriber for this edition of Jim Grant’s free letter. Here is a section:

“For somebody who wants to hedge their borrowing costs, it leaves a lot to be desired. It’s a great product as long as credit spreads remain static. The time it really falls apart is in a crisis.”  

The problem: Unlike traditional Libor, which is compiled by a survey of unsecured bank borrowing costs and represents embedded credit risk, SOFR is based on the overnight cost of borrowing cash collateralized by Treasury securities and is thus highly influenced by monetary policy.  In other words, SOFR can be expected to fall in times of market turbulence, as the Federal Reserve typically reacts to such spasms by reducing the benchmark Fed Funds rate. 

Indeed, while Libor raced higher as markets convulsed in the winter of 2020, SOFR declined in tandem with Fed rate cuts in response to the tumult. “When there is stress on the financial system, that’s when it’s going to really fall short,” Wilson cautioned to Bloomberg. “We need to make sure that your hedging products, especially, work during [those] periods.” Despite the decidedly mixed results seen in the March 2020 crucible, regulators have “decided they want everyone to use SOFR,” he marveled. “I can’t explain it.”

 

Eoin Treacy's view

We are on a long and winding road towards greater central bank and government control of markets. Substituting a market-based rate for a central bank dictated rate is one more step on the road to outright financial repression, as in the 1930s definition of that term.

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