How much have benchmark U.S. interest rates risen lately? 

You may think the correct answer is 25 basis points, or 0.25 percentage point. That’s the amount by which the U.S. Federal Reserve raised its target for overnight interbank rates in December, the only official increase in the past nine months.

Unofficially, though, borrowing costs have gone up by another 35 basis points, equivalent to 1.4 rate hikes that never made it into the headlines. To look under the hood of this stealth monetary tightening, start with the London interbank offered rate, but after subtracting the overnight index swap rate.

The so-called Libor-OIS spread gained popularity during the 2008 financial crisis as a gauge of counterparty risk.  This time, though, something else is going on. Credit default swap spreads aren’t suggesting any concerns about banks’ creditworthiness, as Bank of America Merrill Lynch says. Their cost of funding is going up, and pushing Libor-OIS close to its highest since the European sovereign-debt crisis, for several other reasons.

For one thing, the Trump administration is stepping up deficits -- and sales of Treasury bills -- in an economy near full employment. Competing with the U.S. government for short-term funding is forcing lenders to raise their own borrowing costs.

Complicating matters further, companies such as Apple Inc. and Microsoft Corp. may not be keen to reinvest maturing money-market investments offshore, lest they need to repatriate money quickly thanks to the tax overhaul the Republican-led Congress passed in December. U.S. offshore money-market funds are a source of finance for banks, so the loss of these corporate surpluses would erode liquidity. As a result, borrowing costs are likely to remain elevated, especially as the Fed keeps unwinding its own bloated balance sheet. 

The individual waves have come together to cause a “sea change” in U.S. money markets for banks and investors, according to Bloomberg reporters Liz Capo McCormick and Sid Verma. The ripples are being felt in Asia, especially in Hong Kong, where they’re giving rise to a cottage industry in gloom and doom.

Of late, there has been unnecessary and unhelpful chatter about Hong Kong’s 35-year-old peg to the greenback being at risk. The speculation has arisen because  U.S. dollar Libor is now more than 1 percentage point above Hong Kong’s interbank offered rate, or Hibor.

This gap, the widest since 2008, ideally should not exist. The peg centers on 7.8 to the U.S. currency, and allows for moves between 7.75 and 7.85. Since the Hong Kong dollar is already at 7.8413, why aren’t investors borrowing cheap local currency to buy greenbacks and pocket the juicy difference in interest rates?

While the local dollar is at its weakest in 33 years, it hasn’t yet reached the 7.85 point at which the Hong Kong Monetary Authority is committed to buying the currency. Norman Chan, the authority’s chief executive, says he’s looking forward to funds flowing from into the U.S. currency so the Hong Kong dollar will weaken to that level, whereupon he’ll step in. HKMA buying will cause the city’s monetary base to contract and help local interest rates to normalize.  

Capital inflows from China into Hong Kong stocks, bonds and real estate are partly the reason why the interest-rate gap isn’t closing. But another may be that Libor is no longer working as a reliable compass to anchor Hibor expectations. Some commentators are looking at the net result of an artificially pumped-up Libor and a Hibor weighed down by massive inflows to conclude that if arbitrage isn’t working to narrow the differential, the peg won’t last.

Beyond being a noisy distraction, a wonky Libor threatens to impose real costs. If Hong Kong’s currency does weaken to 7.85, and the monetary authority’s intervention forces local interest rates to rise, how high will they go chasing an inflated Libor?

Banks in Hong Kong are pricing mortgages barely 1.25 percentage points above Hibor to lure home buyers to an overheated market. Should local borrowing costs jump dramatically, new demand would disappear; banks, developers and homeowners would all be hit.

So keep a watch on Libor-OIS. Sneaky monetary tightening in the U.S. has the potential to do some open damage in Asia.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

To contact the author of this story: Andy Mukherjee in Hong Kong at amukherjee@bloomberg.net.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net.

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