Money markets on Thursday gave mixed signals on how durable the recent improvement in conditions is, as signs of economic recovery helped narrow some closely-watched spreads but lingering banking sector concerns widened others. The premium banks charge to lend dollars to each other over expected US policy rates narrowed, as did two-year US and 10-year eurozone interest rate swap spreads.
Data on Thursday showed that the rate of contraction in eurozone manufacturing slowed again and Credit Suisse's first quarter net profit was double consensus expectations, supporting banks' willingness to lend. But disappointment over Morgan Stanley's first quarter earnings and outlook on Wednesday lingered, meaning European banks underperformed the broader index a bit.
While ample short-term money market liquidity is encouraging banks to lend further out the curve rather than hoard it, there's growing consensus the European Central Bank's expected interest rate cut to 1 percent next month will be its last.
This ensured the decline in interbank euro rates ground to a halt - three-month Euribor rose for the first time since October - and the premium paid for euro and sterling London interbank offered rates over anticipated policy rates widened.
"Excess liquidity is being put to use further out the curve, out to one month .... but three-month (euro) rates seem to be forming a base here, which suggests money is not being put to use out that far," said Barry Moran, a euro money markets trader at Bank of Ireland in Dublin. "It's still far from normal. There has been improvement but people are watching what's going on elsewhere in terms of earnings and US banks' stress test," Moran said, referring to the results of regulators' test of banks' strength due on May 4.
The three-month interbank Euribor lending rate rose to 1.406 percent on Thursday from 1.405 percent and the equivalent euro Libor rate, which is drawn from a much smaller panel of banks, was unchanged at 1.40438 percent. The premium for euro Libor over Overnight Index Swap rates widened two basis points to 60 basis points, and the equivalent sterling Libor/OIS spread widened the same amount to 110 basis points.
Comparable dollar rates and spreads fell slightly. The Libor/OIS spread is seen as a gauge of banks' willingness to lend to each other - a wider spread is seen as an indication of decreased inclination to lend. Similarly, interest rate swap spreads are seen as a key measure of broader banking and financial market stress.
The two-year US swap spread narrowed to 60 basis points from 66 basis points on Wednesday, and the 10-year eurozone spread fell to 23 basis points, its lowest in a month. "As far as spreads are concerned, even if it is premature to say the normalisation is quite robust ... risk appetite is gradually recovering. Swap spreads can tighten further in coming days," BNP Paribas said in a client note on Thursday.