Coronavirus explainer: How demand for cash is distorting NZ short term funding markets

Panic has hit the funding market. Photo / AP

Demand for cash is distorting short term funding markets here and around the world as developments surrounding the coronavirus pandemic continues to panic investors.

The scramble for cash as governments and central banks grapple with the effects of the pandemic has re-created conditions in the short term money markets last seen in the 2008-9 Global Financial Crisis and earlier.

"That panic has hit the funding market. In short - people are scrambling for cash as cash is king," Westpac senior markets strategist Imre Speizer said.

"The means by which they can access that through the financial markets is getting more and more expensive."

Banks fund themselves in small part through the bank bill market. When there is a scramble for cash, it's reflected in the yields that the bank bills are issued at.

The money markets use the NZ dollar Overnight Indexed Swap (OIS) as a key tool - as it is seen as the "cleanest" measure of Reserve Bank official cash rate (OCR) expectations.

Under normal conditions, there should be a 20 basis premium between three month bank bills over the OIS rate.

The difference between them - called the funding premium - has now blown out to 45 basis points.

"That (extra) 25 basis points does not sound like much to the person on the street, but an extra 25 basis points for short term funding is like an official cash rate increase," Speizer said.

The three month month bank bill rate is at 0.69 per cent and the OIS is 45 basis points below that - the biggest spread since the Global Financial Crisis.

Some companies can also source US dollar denominated short term funding and convert that to short term NZD funding via the FX swap market.

The big names can effectively flit between borrowing US dollars and converting that to Kiwi or go directly to the New Zealand commercial paper market and take whatever rate is best.

The interest rate that companies pay using the FX swap channel can be expressed as a premium above the equivalent bank bill rate.

That spread right now is 92 basis points - the biggest it's been since the 1990s and bigger than in the GFC.

Overseas governments and central banks have taken steps to address liquidity shortages.

New Zealand's Reserve Bank has not done so - yet.