Three-month euro funding rates marked a euro lifetime low on Tuesday but the downward momentum in bank-to-bank lending rates has slowed as Europe's intensifying banking woes put fresh pressure on money markets. Dollar interbank rates barely moved in Europe but interest rate swap spreads widened on rising risk aversion.
Excitement over a $787 billion US fiscal stimulus bill, which President Barack Obama will sign into law on Tuesday, seemed to be wearing off, replaced instead by concerns over the financial vulnerability of emerging Europe after ratings agencies warned of increasing risks to banks in the region.
Asian and European stock markets fell as investors sought safety in government bonds, driving the two-year eurozone government bond yield to its lowest since the 1999 launch of the single currency. Market expectations that the European Central Bank may cut interest rates by at least 50 basis points to a record low of 1.5 percent next month amid debate about the bank moving to unconventional ways to tackle the eurozone recession has also pushed two-year yields down.
London interbank offered rates (Libor) for euros edged lower to 1.91 percent, the lowest since 1999, while dollar rates were at 1.2456 percent, unchanged from Monday, according to the latest fixings by the British Bankers' Association.
Three-month Libor over OIS rates for euros, dollars and sterling held steady but forward Libor/OIS spreads have been widening over the past week, notably in euros, as the pace of decline in Libor rates has slowed. The three-month Libor/OIS spread expresses the three-month premium paid over anticipated central bank rates, or Overnight Index Swap rates.
"Money market conditions have improved globally and we have seen a correction from the wides we saw end of October and in November, but now at these kind of levels some small pressures are starting to emerge again," said Cagdas Aksu, fixed income strategist at Barclays Capital in London.
"Thus, if things do get worse again like in terms of general market conditions - we are seeing flight to quality type of moves over the past week or so, credit markets widening, stock markets falling and euro area sovereign spreads widening again - it's not going to be helping for further normalisation of Libor/OIS basis spreads that much," he said.
Commercial banks have returned over the past couple of sessions to hoarding cash in the ECB's overnight deposits rather than lending it out, figures showed. The two-year US dollar interest rate swap spread over comparable Treasury yields - a closely watched gauge of investor risk aversion - widened to as much as 73 basis points from 63 basis points late on Monday.
"Risk aversion remains a dominant theme," said Sue Trinh, a strategist with RBC Capital Markets. It was not surprising that market euphoria over the Obama administration's new stimulus plans had worn off, she said. "If you look at the past year or so at how many packages we have received, there is very limited effect in terms of risk appetite on the market. "Most of it has been good for a one-week, knee-jerk rally or so, and it looks like the most recent package is doing the same thing."
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