Credit risk indicators in the United States banking system may be showing signs of stress, as the Federal Reserve's aggressive path of rate hikes raises expectations of economic hardship.
The so-called FRA-OIS spread, which measures the gap between the three-month U.S. forward rate agreement and the overnight index swap rate, increased to 29.50 basis points on Thursday, the widest since May 23, according to data from Refinitiv. The figure was at -11.66 bps earlier in the week.
Widely viewed as a proxy for banking sector risk, higher spreads reflect increased interbank lending risk.
"The recent spike in the gap between the forward rate deal and overnight index swap rates is worrying," said Jordan Jackson, global market strategist at J.P. Morgan Asset Management.
"When the Fed turns more hawkish, there are increasing recession fears and that increases the underlying credit risk."
The Fed raised interest rates by 75 basis points on Wednesday, its biggest increase since 1994, and expectations of more drastic tightening ahead have rattled markets and raised concerns over a potential recession.
The U.S. central bank also this month began allowing bonds to mature from balance sheets of more than $8 trillion without replacing them, a process called quantitative tightening that Jackson says has the potential to weaken liquidity in the financial system.
That echoed the concerns of some other investors, who were concerned that market conditions could worsen as the world's largest holder of US government debt reduces its presence in the market.
"Now that quantitative tightening has officially begun, we've seen reserve drainage quite persistent over the last few months," Jackson said, adding that he expected the spread of FRA-OIS to widen even further.
Wall Street also sees a greater risk of default by big banks. Spreads on credit default swaps from JP Morgan, Goldman Sachs, Morgan Stanley, Citigroup, Wells Fargo and Bank of America neared fresh two-year highs on Thursday.
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