Not since the financial crisis of 2008 has Libor, to which almost $7 trillion of debt including mortgages, student loans and corporate borrowings, is pegged — experienced such a surge. The three-month U.S. dollar Libor rate has jumped from 0.61 percent at the start of the year to 0.87 percent currently — a 42 percent rise — ahead of money market reform that's due to come into effect on Oct. 14.

The new rules require prime money market funds — an important source of short-term funding for banks and companies — to build up liquidity buffers, install redemption gates, and use 'floating' net asset values instead of a fixed $1-per-share price. While the changes are aimed at reinforcing a $2.7 trillion industry that exacerbated the financial crisis, they are also causing turmoil in money markets as big banks adjust to the new reality of a shrinking pool of available funding.

Some $1 trillion worth of assets have shifted from prime money market funds into government money market funds that invest in safer assets such as short-term U.S. debt, according to Bloomberg estimates. The exodus has driven up Libor rates as banks and other corporate entities compete to replace the lost funding.

Now, analysts are debating whether the looming Oct. 14 deadline will mark a turning point for the interbank borrowing rate, as money markets acclimatize to a new reality.

Eoin Treacy's view

A great deal of capital is parked in money market funds overnight because they are considered relatively secure because the NAV is steady. The transition to two types of money market fund; one investing only in government securities with a static NAV and others in commercial paper with a highly variable NAV, represents a major change and will need time for bedding in so the potential for volatility is non-trivial.


3-month USD Libor is trading at 87 basis points, 3-month Treasury paper is trading at 33 basis points so the TED spread has expanded more over the last few months than at any time since 2007 because the question of what it will all mean to tamper with money market funds is not yet resolved. 

This might also be a factor in the surge in yields seen over the last couple of weeks which of course has also been influenced by concerns surrounding interest rate policy. In order to allay fears that interest rates are not about to surge higher the spread will have to continue to contract after the transition on the 14th.