Benchmark dollar funding costs dropped to new record lows on Tuesday even though improvements in the economic backdrop have been pushing up US Treasury yields and longer term corporate borrowing benchmark rates. In Europe, shorter-dated rates continued to fall as banks helped themselves to a larger amount of excess funding at the European Central Bank's weekly tender, slowing their attempts to wean themselves off the support system.
Three-month dollar Libor rates eased to a new low of 0.64625 percent, while the spread over Overnight Indexed Swap rates narrowed to 44 basis points, its tightest since early 2008. While Libor rates continued to trend lower, other yields remained around their highest levels in months.
The evidence of a broad global economic recovery came from manufacturing surveys and US income data this week, furthering the rally in stock markets and risky assets and pushing down the US dollar index to a near six-month low on Monday.
Ten-year US Treasury yields saw their biggest spike in eight months overnight, although bargain hunters stepped in to pick up paper during Tuesday's European session.
Besides the optimism over the economic rebound, the recent rise in yields also reflects concerns about soaring government debt issuance levels and the prospect of rising inflation as the economy recovers.
The change in expectations was also reflected in rate futures contracts. December 2012 Eurodollar futures fell to 95.5 from 96.40 two weeks ago, pushing implied future interest rates higher by around 90 basis points. Overnight deposits at the ECB fell overnight, data showed on Tuesday, but they remained above last week's eight-month low.
At the ECB's weekly auction, banks borrowed 227.6 billion euros of 7-day funds compared with 277 billion euros last week. However, when taking into account the ECB's forecast liquidity requirement, the amount of excess liquidity the banks took almost doubled to 45.6 billion euros.
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