Dollar interbank funding costs rose near four-month highs on Monday as the loss of one of the US top-notch credit ratings and doubts about the efficacy of stepped-up ECB bond purchases stoked worries a broader financial crisis was developing. Investors drove global equities down to 11-month lows after Friday's cut by S&P compounded market jitters over a shock downgrade to US economic growth and worries that the eurozone's debt troubles are entering a more dangerous phase.
A move by the European Central Bank to buy Italian and Spanish bonds supported lower-rated eurozone sovereign bonds but this was seen short-lived given unease over the size of the programme and how long it could last. London interbank offered rates for three-month dollars rose to 0.27478 percent, their highest level since mid-April, from 0.27161 percent on Friday.
The risk premium on unsecured dollar lending, measured by the gap between Libor and expected central bank rates, surpassed recent peaks to 19 basis points, early April highs. "It's not only just about the US credit rating downgrade. It's also about the creditworthiness of European institutions in the uncollateralised interbank market given what's happening on the sovereign debt front," said BNP Paribas strategist Alessandro Tentori.
In the euro/dollar cross currency market, where a bank can swap euro interest payments with a lender in exchange for dollars, the three-month cross rate was at -66 bps from -61 bps on Friday. This is more than 30 basis points wider in the past two weeks but still way off a spike to minus 300 basis points seen in the fourth quarter of 2008 when money markets froze after Lehman Brothers collapsed. "Fundamentally it's a sign of stress driven by demand for dollars. Euro money managers who are short dollars and who need to get back into dollars have largely driven that (move) in the last couple of weeks," said Chris Walker, a UBS FX strategist.