Dollar funding costs for eurozone banks rose on Friday on fears that a bleak economic outlook in the United States and the spreading eurozone debt crisis could take a heavy toll on the region's banking sector. Investors sought dollars via FX swaps while short-term money market rates in Switzerland and Singapore traded in negative territory with no immediate end in sight to the turmoil that has hit shares, including banks, in recent days.
The three-month euro-dollar cross currency basis swap, which falls when dollar funding costs for eurozone banks rise, had stabilised at slightly higher levels this week compared with last week's 2-1/2 year lows. The stabilisation came as one bank became the first to tap dollar funds at a European Central Bank auction since February on Wednesday. Although a sign that the bank was unable to access dollars more cheaply in the market, the move reminded investors that measures are in place to deal with liquidity shortages.
But on Friday, the swap fell about 6 basis points to minus 88 bps, as some US lenders preferred to hold on to their cash rather than lending it to some of their eurozone counterparts after a key measure of US manufacturing activity hit a 2-1/2-year low on Thursday.
"We've seen signs of some pressure emerging... particularly with the increasing recession risks - people are increasingly using that term after the data yesterday," said MF Global strategist Philip Tyson. The swap hit its lowest since end-2008 at just below minus 90 bps last week, still way off record lows of below minus 300 bps hit at the time of the Lehman collapse.
In another sign of increasing stress, the three-month dollar Libor spread over overnight index swaps widened by 2 bps to a new one-year high of 21 bps - also, way below 2008 highs of more than 360 bps. In euro markets - Libor/OIS spreads rose by 8 bps to 61 bps, off recent lows, but four times the levels seen before the Italian debt selloff started at the beginning of July.
As investors increasingly look for ways to preserve their capital rather than get meaningful returns on it, more and more cash has been piled up in safe-haven Swiss assets, which forced the Swiss central bank to come up with measures to boost liquidity and weaken the currency. This has sent the three-month Swiss franc rate to a record low of 0.00833 percent.
Euribor rates fixed lower on Friday under the weight of heavy excess liquidity in the interbank market and a growing belief the ECB will keep interest rates on hold well into 2012. Euribor futures, which rallied by more than 20 basis points on Thursday after the Philly Fed data, were stable or slightly lower across the 2011-2014 strip, implying little change in ECB interest rates.
BNP Paribas strategist Alessandro Tentori recommended long positions in the December Euribor future to hedge against a potential repeat of the post-Lehman co-ordinated interest rate cuts by major central banks. The contract was last 1 bps lower at 98.81, after rallying more that 20 bps during Thursday's session.