Money markets investors tip back to foreign bank debt

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* 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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