A key gauge of counterparty risks rose to its highest since the beginning of this year on Tuesday as a potential default in the United States and obstacles to the implementation of a Greek debt deal kept money markets on edge. The United States is edging closer to a devastating default as Republicans and Democrats struggle to find a deal on raising the debt ceiling. Such a deal is needed by an August 2 deadline, when the country runs out of cash to pay its bills.
Benchmark three-month interbank lending costs for euros rose amid speculation that the eurozone Greek rescue deal could face roadblocks. Among them, some bondholders may choose not to participate in the crucial debt exchange. "Over the past couple of days we have had a (re-escalation) of the crisis in the euro zone because the Greek deal isn't seen to be a solution and at the same time we have the debt ceiling saga in the US It all contributes to tension," said Peter Schaffrik, head of European rate strategy at RBC Capital Markets.
The gap between three-month Libor and expectations of central bank rates in the eurozone - a measure of counterparty risk - rose six basis points to 26 bps but was still below 100 bps scaled at the height of the financial crisis two years ago. The equivalent three-month dollar Libor/OIS spread was steady at 14 basis points. "There is some nervousness from banks around their ability to borrow or lend at the other side to other counterparties," Chris Huddleston, head of money markets at Investec said.
Benchmark interbank funding costs in eurozone money markets rose slightly. The London interbank offered rate for three-month euros rose to 1.56 percent from 1.558 percent on Monday. The dollar equivalent was fixed at 0.2526 percent from 0.2521 percent the day prior. The deterioration of the eurozone crisis has prompted investors to scale back expectations of a further European Central Bank rate hike, with analysts expecting an increase only in mid-2012.