The interbank cost of borrowing three-month dollars on Tuesday edged up for the first time since late March as banks reduced their reliance on central bank funding despite persistent concern about counterparty risk. After declining for two months, the descent of the global London interbank offered rate (Libor) has stalled as bank lenders and borrowers try to come to terms with a still perilous market environment nearly two years after the global financial crisis first erupted.
Governments' unprecedented cash injections into the banking system globally and securities markets have helped restore some confidence and a semblance of order to short-term lending markets. Lower borrowing rates, albeit not back down to their long-term historical averages, now reflect these conditions, some analysts said. "We are reaching a new normal," said Tony Crescenzi, chief bond market strategist with Miller, Tabak & Co in New York.
"There is no question in this environment that people are still worried about counterparty risk and the banking system, so there has to be a wider spread of Libor to fed funds" than before the credit crisis, Crescenzi said. Before the global credit crunch started to bite in the summer of 2007, the spread of 3-month Libor over the fed funds target rate - the key interbank lending rate the US central bank sets - was typically between about 12.5 and 25 basis points, Crescenzi noted.
But with repercussions from the biggest banking crisis since the Great Depression still roiling markets, the new range for this spread may be higher, within about 45 basis points of the upper edge of the Fed's zero-to-0.25 percent range for the target rate, he said.
Dollar-denominated Libor rates, a key global benchmark, which have been setting record lows on a daily basis this month, rose a third of a basis point to 0.66375 percent on Tuesday. Benchmark three-month euro Libor rates rose half a basis point to 1.270 percent.
Eonia overnight rates rose above 1 percent on Friday, and above the European Central Bank's key refinancing rate after trading below it for most of the time since October, suppressed by the European Central Bank's unlimited liquidity provision. The rise in the overnight rate, coupled with falling deposits at the ECB, may be signs that banks are starting to get a better feel for their true liquidity requirements, and get back into the swing of interbank lending.
The two-year US interest rate swap spread over Treasuries - a gauge of risk aversion - narrowed by about half a basis point on the session to 40 basis points. Early last week however, this spread had tightened to less than 30 basis points - levels last seen in February 2007, months before the credit crisis started. Even with market sentiment showing tentative signs of improvement, analysts said rates had simply come down too far, too fast in recent months and a backup was overdue.
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