Traders Puzzled After Libor Tumbles Most In 10 Years

While Libor remains a vestige of a bygone era in which unsecured overnight bank lending still mattered - hence made obsolete by $1.5 trillion in excess reserves sloshing around - traders are puzzled by the sharp move in 3M USD Libor this morning, which on Thursday morning was fixed lower by 4.063bp, falling from 2.73763% to 2.69700%.

Libor fell to 2.69700% from 2.73763%, making it the largest one-day drop since May 2009.

While Libor, beset by a decade of scandals including massive manipulation that involved most banks during the financial crisis, is on its way out and set to be replaced by the Fed's SOFR alternative in two years, it is still a reference security for trillions in floating-rate debt, and more importantly, remains the primary way to bet on short-term interest rates via eurodollar futures which settle into Libor, and according to Bloomberg, has 12.52 million contracts in open interest, vastly more than Fed Fund futures which have total positioning of only 1.8 million contracts (SOFR remains an experimental speck with just 85K futures after 9 months of existence).

As such today's massive move has prompted lots of question, and no answers for the violent move lower.

Making matters worse, whereas previously there would at least be disclosure of LIBOR fixing by bank, which in the days leading up to the financial crisis would allow traders to discern which financial institution is suffering from liquidity shortage - and prompted even more Libor manipulation by member banks to hide their financial troubles - the current iteration no longer provides this level of transparency. Or any level for that matter.

"That a key benchmark can exhibit such sudden volatility with no observable rationale" is a problem according to Bloomberg commentator Cameron Crise, although according to Nomura's Charlie McElligott, "the move could be driven by an adjustment towards current 90d CP rates" as CP yields have been falling even as Libor has been relatively flat, prompting speculation that Libor was overdue to catch down to CP.

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