A benchmark on what banks charge each other for dollars fell to a 2-1/2 month low on Friday on bets that the Federal Reserve will cling to an ultra-loose monetary policy at least a year from now.
Across the Atlantic, key bank-to-bank lending rates on euros slipped, but the dip did not signal a fundamental change to the overall trend of rising rates there. Analysts predict they will rise above the European Central Bank’s 1 percent refinancing rate by the end of the year.
There is growing evidence that the U.S. economic recovery is slowing due to high unemployment and a struggling housing market. This has raised expectations that the Fed needs to maintain its target for the federal funds rate in a zero to a quarter percentage point range into late 2011.
The steady decline in dollar loan costs since June has accelerated since Fed Chairman Ben Bernanke told U.S. lawmakers last week of his “unusually uncertain” economic outlook, said Lance Pan, director of research at Capital Advisors Group in Newton, Massachusetts. (Traders) “expect the Fed may be more accommodative.”
There has been speculation the Fed could renew purchases of Treasuries and mortgage securities to lower long-term borrowing costs. But the Fed has given no hints it will take up these quantitative easing measures again any time soon.
Still, the current rock-bottom rates have bolstered banks’ profits and repaired their balance sheets, which were battered by investments that soured after the U.S. housing bust.
“This is best accomplished by looking at inter-bank rates, which steadied over a month ago and are in the midst of a persistent and accelerating decline,” said Tony Crescenzi, portfolio manager at Pacific Investment Management Co, in Newport Beach, California.
The London interbank offered rate on three-month dollars USD3MFSR= was fixed at 0.46563 percent, the lowest since mid-May, while its spread to the three-month Overnight Indexed Swap rate, a gauge of money market stress, shrank to 27 basis points, the smallest gap since May 20. See [ID:nEAP000047]
The futures market signaled interbank dollar rates will extend their current downtrend.
Eurodollar futures <0#ED:> for delivery from August to Dec 2013 posted contract highs.
EUROPEAN RATES PAUSE
Key euro interbank lending rates dipped on the day, stalling a long-term rise, as the cost of borrowing in the money market has become gradually less attractive relative to funding from the European Central Bank.
“This will be indicative of the coming months, in the sense that the sharp rise in money market rates is coming to an end and we’re switching to a more slow-moving trajectory,” Elwin De Groot, senior market economist at Rabobank in Utrecht, Netherlands, said of Friday’s rate fall.
The cost of European interbank borrowing has been suppressed by the flood of cheap funding pumped into the euro zone banking system to keep money markets liquid after the collapse of Lehman Brothers in Sept. 2008.
The prospect of an end to the unlimited, fixed-rate ECB loans, scheduled to be phased out by the end of the year, has led market participants to start competing for funds in the interbank market, driving costs higher.
Overnight rates, which underpin longer-term borrowing costs in money markets and the wider economy, eased and relieved pressure on benchmark euro Libor and Euribor fixings.
Three-month Euribor EURIBOR3MD= fell for the first time since mid-April to 0.896 percent and equivalent euro Libor EUR3MFSR= fixed a fraction lower at 0.83250 percent after rising for 11 consecutive sessions.
After the fixing, investors moved quickly to price in lower rates into next year as Euribor futures <0#FEI:> rallied around 3 basis points across the curve. (Additional reporting by John Parry in New York; Editing by Dan Grebler)