Goldman: Recent Dec FRA-OIS Compression Vulnerable To Year-End Pressures

Goldman Sachs note that “following a widening into the middle of June, December FRA-OIS has compressed some 5-to-6bp to the mid-20s over the last week or so, with the U2/Z2 FRA-OIS curve flattening sharply in the process. Although relief is being priced, it is not clear this is warranted. Some of the larger money center banks saw greater-than-expected increases in their estimated stressed capital buffers relative to limited excess capital, which should prompt continued and likely intensified balance sheet mitigation - our banks’ analysts note that risks are towards even greater than usual efforts on trying to mitigate G-SIB scores in Q4. While there are a range of ways in which to try to go about these mitigation efforts, to the extent that banks manage in part by scaling back on activities such as FX swaps and repo financing, we could see renewed pressure on dollar funding costs over the year-end. While FX forwards spanning year-end and the U2/Z2 FRA-OIS slope suggest some amount of this risk is priced, it does not appear all that pronounced by historical standards, suggesting vulnerability to some reversal wider.”