As the Federal Reserve’s aggressive rate rise path raises prospects of economic suffering, a credit risk indicator in the US banking sector may be exhibiting indications of stress.

According to Refinitiv data, the FRA-OIS spread, which gauges the difference between the three-month forward rate agreement in the United States and the overnight index swap rate, climbed to 29.50 basis points on Thursday, the widest since May 23. Earlier in the week, the indicator was at -11.66 basis points.

A greater spread suggests increased interbank lending risk, which is often seen as a proxy for banking sector risk.

“The recent spike in the spread between forward rate agreement and overnight index swap rate is concerning,” Jordan Jackson, a global market strategist at J.P. Morgan Asset Management, said. “As the Fed becomes more hawkish, there is an increase in recession concerns, which raises the underlying credit risk.”

The Fed hiked interest rates by 75 basis points on Wednesday, the largest rise since 1994, and predictions of more tightening have shook markets and prompted concerns about a possible recession. more info

This month, the central bank also started letting bonds to age off its more than $8 trillion balance sheet without replacing them, a procedure known as quantitative tightening, which Jackson warned might reduce liquidity in the banking system.

This mirrors the fears of some other investors, who are concerned that market conditions may deteriorate if the world’s biggest holder of US government debt lowers its market participation. more info

“Now that quantitative tightening has officially started, we have seen reserve drainage pretty persistent over the last several months,” Jackson said, adding that the FRA-OIS gap will expand considerably further.

Wall Street is also concerned about the increased danger of significant bank failure.

Source: Reuters

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