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Money markets ecb rate cut may limit money market appeal


LONDON, May 1 An ECB rate cut this week would limit moves in the money market in future but may also prevent borderline healthy banks returning to the market and dull its appeal for others. While the European Central Bank is widely expected to cut its main interest rate to a record low 0.5 percent on Thursday, market prices show investors believe it will keep its deposit rate at zero for the foreseeable future. That would soothe the concerns of those who warn a negative deposit rate could wipe out unsecured lending market, but would also narrow the corridor between the main rate and deposit rate in which money market rates move. With so much cheap ECB money in the system and key bank-to-bank lending rates at just 0.2 percent, the change is unlikely to matter until liquidity levels drop and market rates begin to move more freely again. In the last few years, the ultra-easy conditions created by the ECB mean interbank rates hardly budge even during a flare-up in the euro zone crisis. "It is a story for the future really, but what it (a rate cut) does is lower your effective ceiling for market rates," said Nomura rate strategist Guy Mandy. "In that lower-for-longer environment volatility should be dampened but there are still risks in that Europe is still not a safe place." NARROW CORRIDOR Though worries about the future of the money market remain centred on the slim chance the ECB cuts its deposit rate, academic research suggests narrowing the gap between the main and deposit rates can restrict lending. Research by Ulrich Bindseil, head of the ECB's market operations department, shows that the tighter the corridor, the more banks tend to borrow from the central bank rather than on the open market. Trading turnover roughly halves if the gap narrows from 75 basis points to 25. "Initially, in a zero corridor regime, there is no interbank trade independently of the level of transaction costs. As the corridor gets wider, interbank transactions appear more profitable and interbank trade kicks in," one paper concluded. Some economists expect a further rate cut later this year. In that case, if benchmark three-month market rates remained at 0.2 percent as expected, the risk reward would be minimal and the option to borrow from the ECB at 0.25 percent might be too tempting for some to pass up. But traders say the theory ignores the heavy stigma within the banking community attached to borrowing from the ECB. "The incentive banks have to go to the unsecured market is not about the rate, it is about not depending on official aid and not having to pledge collateral," said one euro zone-based money market trader who requested anonymity. "In my eyes, the approach of saying the unsecured market will suddenly become less attractive because the ECB will be at 0.50 as opposed to 0.75 percent doesn't make any sense." Analysts say that it is the banks in Greece, Spain, Portugal, Italy that remain most dependent on the ECB for their funding who will be the biggest winners from a rate cut. Not only will they get cheaper funding but the money they borrowed in the ECB's two three-year LTROs will also become cheaper as the rate on those loans tracks the refi rate. But for banks recovering from the worst effects of the crisis, it could delay attempts to return to the open market. "For most of us we are just not lending to those (periphery) banks it is as simple as that," said one London-based trader. "But are those banks realistically going to get a lower rate than 0.5 percent? Probably not."

Money markets euro zone stress creeps into money markets


* Currency basis swaps widen, LIBOR/OIS spread stabilises* Counterparty risk seen increasing but not to Q4 levels* Spain to test market sentiment for its debt on ThursBy Ana Nicolaci da CostaLONDON, April 17 The cost for banks of swapping euros into dollars has risen since the beginning of April - the latest sign that Spain-fuelled stress in euro zone debt markets is beginning to creep into money markets. Yields on Spanish 10-year government bonds broke above the important 6 percent mark this week, with the country's Treasury poised to test market appetite for its bonds on Thursday. Strong demand at a Spanish bill auction on Tuesday offered some respite for peripheral debt in secondary markets but a rise in short-term borrowing costs underscored the challenges still facing the highly indebted country.

Its austerity drive risks pushing the euro zone's fourth largest economy deeper into recession - a plight that could be exacerbated if yields rise to prohibitive levels. Such concerns have started to seep through into money markets as the impact of one trillion euros worth of cheap European Central Bank funding injected into the financial system in December and February also start to fade. The euro/dollar one-year cross currency basis swap , which widens when lenders charge more for swapping euro interest payments on an underlying asset into dollars, was at -59 basis points, not far from -60 bps hit in the previous session - its widest in around six weeks.

"It's Spain, as simple as that," said a trader, explaining the move. "What happens when there is a little bit of stress in the market - and it has been Spain for the last two weeks - (is that) the cross currency goes up because it's basically harder to get dollars."Meanwhile, measures of counterparty risk in the interbank market have also stabilised since the beginning of April. The spread between three-month euro Libor rates and overnight indexed swap rates last stood at 31 bps, little changed from around 30 bps at the beginning of April. In March, that same spread fell by more than 20 bps.

"I guess it's a case of how much juice there was to be extracted from these ECB operations," Simon Smith, chief economist at FX Pro said."It seems to be getting to a stage where most of the juice has been squeezed out of it and I think that's why we are seeing a degree of stabilisation and in some sense also some widening," he said. Smith said the risk was for further widening, but it would be modest and would not reach levels hit in the fourth quarter of last year, when euro zone debt market stress heightened. The Libor/OIS spread could nudge back towards 40 basis points over the next five to six weeks, Smith said. That would be less than half the levels reached in December of last year. Smith said the one-year cross currency basis swap could head towards -70 basis points over the next tree to four weeks - also still a way off levels of almost -110 bps hit in the fourth quarter of last year.

Money markets investors tip back to foreign bank debt


* Money funds bought Japanese, Nordic debt in June-Fitch* Japanese debt seen as alternative to U.S. securities* U.S. two-year swap spread tightest since August 2011* Eurodollar futures, 3-month dollar Libor fallBy Richard LeongNEW YORK, July 26 Investors are dipping their toes back into Japanese and other less risky foreign bank debt due to worries about the euro zone debt crisis worsening again. Data released this week suggest some investors are buying commercial paper and other short-dated securities from these banks as alternatives to U.S. government securities and repurchase agreements. The amount of commercial paper outstanding issued by foreign banks has grown for three straight weeks. It rose $3.4 billion in the week ended July 25 to $133.4 billion, the highest level since the last week in May, U.S. Federal Reserve data released on Thursday showed. While the Fed neither names the foreign banks nor breaks down the supply by region in its weekly report on commercial paper, it is reasonable to conclude the increase stemmed from foreign banks outside the euro zone, analysts said."There are still significant concerns about the situation in the euro zone. European banks are in the spotlight," said Sean Simko, head of fixed income management at SEI Investments in Oaks, Pennsylvania, which has $189 billion under management.

Only a handful of Dutch, German and French banks have been selling commercial paper regularly to raise cash to help fund their trades and daily operations. Analysts said their issuance activity has not changed much in recent weeks. On the other hand, there has been a steady pickup in commercial paper issuance from Japanese banks, propelled by appetite from U.S. money market funds."Japanese banks have gotten more active," said Lance Pan, director of investment research and strategy with Capital Advisors Group in Newton, Massachusetts. The 10 biggest U.S. prime money market funds increased their exposure to Japanese banks by 11 percent in June from May, Fitch Ratings said in a report released late Thursday.

Their Japanese bank exposure has doubled since the end of May 2011 to nearly 12 percent of their total assets, according to Fitch. Specifically, their combined holdings in Japanese bank commercial paper was 0.7 percent at the end of June, unchanged from May and compared with none in May 2011. These funds also owned more Nordic bank debt last month, growing 15 percent from May to 5.5 percent of their combined assets, Fitch said. In the meantime, these large funds, which represent about a quarter of the industry's $2.5 trillion in combined assets, reduced their exposure to euro zone debt holdings to 8 percent of their combined assets in June. That was the lowest level since Fitch began monitoring these funds' holdings at the end of 2006.

ECB'S DRAGHI REMARKS With heightened anxiety about Spain's finances and whether Greece might leave the euro zone, European Central Bank President Mario Draghi vowed to do whatever was required to avert a euro zone meltdown. Draghi's remarks raised expectations of bold measures from ECB and perhaps European leaders to contain the region's festering debt crisis. This sparked a rally in world stocks, the euro and other risky investments, while they caused a sell-off in U.S. Treasuries and interest rates. Eurodollar futures for 2015 to 2019 delivery snapped their four-session winning streak when they posted a series of contract highs. The December 2015 contract was down 1 basis point at 99.000, slightly below its contract high of 99.025 set on Wednesday. The likelihood of more ECB action that will stabilize the banking system helped narrow the spread between the two-year U.S. interest swap rate and two-year Treasuries to its tightest level since last August. The two-year swap spread was last quoted at 21.25 basis points midmarket from 22.00 basis points on Wednesday. Benchmark three-month dollar Libor fell to 0.44710 percent, its lowest level since Nov. 8 when it was fixed at 0.44417 percent.

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Money markets more ecb cash might not unlock lending


Any further offer of cheap cash to banks by the European Central Bank might increase liquidity in the euro zone's banking system but is likely to have little impact on lending to the wider economy. ECB Governing Council member Luc Coene said on Monday that extending the central bank's long-term refinancing operations (LTROs) was one of several options available should it wish to loosen monetary policy further to ease Europe's debt crisis. To try and tempt banks into new lending, he suggested the ECB could accept private credit claims - typically loans to firms and households - as collateral.."The focus is on trying to get banks to lend to the non-financial sector and this is more evidence that this is what the ECB is thinking about," said Morgan Stanley's global head of interest rate strategy Laurence Mutkin. Banks' borrowing from the ECB has stabilised since the central bank held its second three-year cash offer at the end of February which took banks' borrowing from it at maturities of more than three months to over a trillion euros. On top of that, lenders are taking around 120 to 130 billion euros in weekly funding, according to ECB data.

"The theory is that if banks want to access this facility they'd have to lend in order to have the collateral they would need at such a lending window," said Rabobank rate strategist Richard McGuire. The problem is that although banks have borrowed a vast amount from the ECB, the money is failing to reach the wider economy where it could stimulate spending and growth. Regulatory requirements to hold more capital combined with tighter lending criteria means that banks are holding onto cash.

Over 400 billion euros above and beyond that necessary to meet the ECB's average reserve requirements is being left at the ECB each night, Reuters data shows. ECB money supply data has also shown that a credit squeeze has persisted this year despite all the efforts to provide liquidity, with private sector lending slowing. The most recent figures showed loans to households in the euro zone fell in July, reflecting weak domestic demand, while loans to companies ticked up only slightly.

Meanwhile, research by JPMorgan shows that although central bank balance sheets in the United States, the euro zone, Japan and Britain have expanded by around 125 percent since August 2008, money supply has only increased by 33 percent."Major developed economies are in a 'liquidity trap', the bank's global asset allocation team wrote in a recent note. "Central Banks are creating reserves but this does not increase the money stock as bank lending remains weak."But money supply is in line with demand, JP Morgan concluded, suggesting that potential borrowing remains subdued. Morgan Stanley's Mutkin said factors may be inhibiting banks' willingness to lend that are unlikely to be solved by the ECB providing more cash."Banks are thinking about their credit rating, their shareholders and creditors and ... what these stakeholders think is the right size of balance sheet to have," he said."So it's not the case the ECB can (offer more liquidity) and change banks' behaviour, but it is further evidence they will try lots of things to make this work."