Short-term loan markets showed more signs of strain on Thursday, as the dark cloud over the global financial system lingered, raising the borrowing costs in some key sources of funding. Interbank borrowing costs on the dollar rose broadly for a second straight day in London with the benchmark three-month London interbank offered rate (Libor) at its highest in more than a week.
"Fundamentally, dollar Libors are more vulnerable now," said Guillaume Baron, analyst at Societe Generale in Paris. "In euro and sterling, you still have interest-rate cuts priced into the curve and central banks will deliver, so you can expect fixings to continue to fall because the OIS (Overnight Index Swap) component will continue to fall. That has disappeared in the US market."
Outside of the banking sector, the US commercial paper market contracted for a second straight week, led by a hefty drop in the asset-backed sector. Dollar Libor rates from overnight to one-year terms were all fixed higher on Thursday with the one-year rate gaining the most, up 8 basis points at 1.92 percent.
The spread of three-month dollar Libor over anticipated central bank rates, or Overnight Index Swap rates - a gauge of interbank market tension - widened slightly to 96 basis points and was off this month's low around 91 basis points.
Libor rates for euros and sterling eased. The downtrend in overnight dollar Libor rates came to a halt after the Federal Reserve cut its target rate to near zero last month and the recent flare-up in banking jitters has helped drive those rates higher.
US banks' dismal earnings and growing speculation about the nationalisation of UK banks heightened anxiety in a sector already suffering from a crisis of confidence. One closely watched gauge of investor risk aversion was this week's widening of the yield gap between two-year US dollar interest-rate swaps over Treasuries. At midday on Thursday, this spread hovered at 67.00 basis points - a two-week wide.
The resurgence in market jitters was also reflected in a bigger dollar TED spread. This measure of the spread that interbank rates trade over Treasury yields jumped to 105 basis points from a low of 95 last week. Sally Auld, interest-rate strategist at J.P. Morgan Chase in Sydney, said it's not surprising that swap spreads and TED spreads have widened again. Worries about the bank sector seemed to be spreading to other parts of financial system.
The US commercial paper market contracted for a second straight week, its longest contraction since October, led by a sharp fall-off in the asset-backed sector, Federal Reserve data released on Thursday showed. Commercial paper outstanding shrank $30.3 billion in the week ended January 21 after contracting $45.8 billion in the previous week. The back-to-back decline nearly equalled the $83.1 billion jump registered in the first week of January.
"This is year-end stuff coming due. Next week, you could even see a bigger contraction," said Rudy Narvas, senior strategist at 4Cast Ltd in New York. The size of the US commercial paper market, a vital source of short-term funding for daily operations at many companies, fell to $1.688 trillion in the week ended Wednesday, from $1.719 trillion the previous week, according to the Fed.