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Dave Forest

Dave Forest

Dave is Managing Geologist of the Pierce Points Daily E-Letter.

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The Derivatives Loch Ness

Something unusual is happening in the global swaps markets.

We expected this for the U.S. New rules requiring central clearing of formerly OTC-traded derivatives for big traders came into effect June 10. This includes interest rate and credit default swaps.

The numbers already show the effects of the regulations. CME Group said yesterday their clearing of interest rate swaps jumped 64% in June month-on-month, to $66 billion.

Here’s the unexpected part. The surge in derivatives trading also seems to be reverberating around the world.

In Singapore, daily average volumes in derivatives trading hit a new monthly record in June. Up 77% from June 2012.

Same in India, where exchanges also set a June record for value of derivatives traded.

These happenings remind me of those photos of the supposed Loch Ness monster. You only see a small part of the creature–a head, a fin, some scales–emerging from the water. Never the whole beast, which always stays hidden beneath the murky lake.

Increased global derivatives trading could be a “Loch Ness”. A sign of something bigger happening below the surface of global finance. Remember, the new trading rules for swaps are aimed at regulating a market worth $515 trillion globally. When you poke a monster that size, there’s a lot that could go wrong.

Of course the recent uptick in trading could also be simply a result of recent market volatility. But there are other “Loch Ness” photos emerging that suggest otherwise.

UK banks have been raising their fixed mortgage rates this week. The reason? One lending official attributed the rise to “on going increases to swap rates”, which banks use to hedge their exposure to interest rates.

The same thing is happening in the U.S. The 30-year fixed mortgage is up nearly 1% over the last two months. The largest increase in years.

Might new trading rules on swaps be affecting prices for these instruments? Increasing costs for swaps users like banks, who are passing the increase along to mortgage consumers?

There a lot of flippers and scales starting to poke out of Loch Swaps. Keep your cameras ready.

Here’s to spotting the monster before it eats you,

By. Dave Forest


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