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LOIS Is Screaming

David Kotok profile picture
David Kotok

Today, we look at the warning that the widening spread between the LIBOR rate and the OIS rate may be sounding about what lies ahead, given a two-pronged Fed tightening policy. Whether investors realize it or not, this spread (LOIS) impacts what strategies make for successful investing. This five-minute read will bring readers up to speed.

We will start with Daniel Kurt's Investopedia post, "What is the OIS LIBOR Spread and What Is It For?," from Feb. 21 of this year:

"A decade ago, most traders didn't pay much attention to the difference between two important interest rates, the London Interbank Offered Rate (LIBOR) and the Overnight Indexed Swap (OIS) rate. That's because, until 2008, the gap, or 'spread,' between the two was minimal. But when LIBOR briefly skyrocketed in relation to OIS during the financial crisis beginning in 2007, the financial sector took note. Today, the LIBOR-OIS spread is considered a key measure of credit risk within the banking sector. (For a glimpse into the possible evolution of these two rates, read 'Will OIS Replace LIBOR?')" (Read further here)

The LIBOR-OIS spread (or LOIS) has widened by twice the amount that the Federal Reserve has hiked rates. There are reasons for that, and we will discuss them below. But the impact of the LOIS's widening is at hand today.

Think of it this way. The Fed sets the OIS as it determines the short-term policy rate. If the Fed wants to tighten policy by raising the short-term rate a quarter point, it has the complete power to do so. But the Fed cannot control those market forces that react to the Fed and to other factors. So, if the Fed hikes a quarter point but market forces actually translate that hike into a half point, is the impact of the Fed's quarter point magnified and, in this

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David Kotok profile picture
David Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. David’s articles and financial market commentaries have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to Bloomberg TV and Bloomberg Radio, Yahoo Finance TV, and other media. He has authored or co-authored four books, including the second edition of From Bear to Bull with ETFs and Adventures in Muniland. He holds a B.S. in economics from The Wharton School of the University of Pennsylvania, an M.S. in organizational dynamics from The School of Arts and Sciences at the University of Pennsylvania, and an M.A. in philosophy from the University of Pennsylvania.David has served as Program Chairman and currently serves as a Director of the Global Interdependence Center (GIC), www.interdependence.org, whose mission is to encourage the expansion of global dialogue and free trade in order to improve cooperation and understanding among nation states, with the goal of reducing international conflicts and improving worldwide living standards. David chaired its Central Banking Series and organized a five-continent dialogue held in Cape Town, Hong Kong, Hanoi, Milan, Paris, Philadelphia, Prague, Rome, Santiago, Shanghai, Singapore, Tallinn, and Zambia (Livingstone). He has received the Global Citizen Award from GIC for his efforts. David is a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), has served on the Research Advisory Board of BCA Research and is currently on the advisory board of RiskBridge Advisors. He has also served as a Commissioner of the Delaware River Port Authority (DRPA) and on the Treasury Transition Teams for New Jersey Governors Kean and Whitman. Additionally, he has served as a board member of the New Jersey Economic Development Authority and as Chairman of the New Jersey Casino Reinvestment Development Authority.

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