Money markets key interbank lending rates ease

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* 3-mo Libor rate eases* 3-month euro/dollar cross currency basis swap narrows* U.S. money funds bank more aggressively on EuropeBy Ellen FreilichNEW YORK, March 21 After pricing out some of the expectations for a third round of quantitative monetary easing, some U.S. interest rates eased a bit on Wednesday, but in the interbank lending market, three-month Libor eased after having been flat for several days. The benchmark three-month London Interbank Offered Rate (LIBOR) fixed at 0.72357 percent on Wednesday, down from 0.73214 percent on Tuesday. The three month euro/dollar cross currency basis swap , another gauge of dollar funding risk, narrowed to minus 58 basis points, the tightest in nine months.

The measure, which widens in times of funding stress when investors compete for dollars, has gradually tightened from November's minus 167.5, a level not seen since the aftermath of Lehman Brothers' collapse in late 2008. The relaxation was said to be tied to good economic data, especially from the United States, and optimism among some investors about euro zone sovereign debt. Three-year loans from the European Central Bank (ECB) have also contributed mightily to alleviating worries about counterparty risk. After a week of mainly adding risk, investors tried the reverse tack on Wednesday with global stocks drifting lower and safe-haven government debt prices rising. Last month, however, the latest period for which data was available, figures on taxable money funds showed those funds ready to participate a little more aggressively on Europe.

Money fund holdings of French bank deposits, commercial paper and repo increased by 14 percent, returning to their October level. Since these holdings troughed in December, French bank exposures have increased by 72 percent, but are still half what they were in May 2011, said Barclays Capital market analyst Joseph Abate."After reducing their exposures too far, money funds appear to be looking for a 'happy medium' between the two extremes," he said.

Scandinavian, German, and UK holdings by money market funds were largely unchanged in February. Weighted average maturities of money fund European bank exposures also lengthened in February, consistent with overall market "risk on" sentiment, Abate said. As firms lock in low rates by borrowing for longer periods, the weighted average maturity on commercial paper outstanding has lengthened to 47 days from 39 in September, he said. As interbank lending rates have eased, money fund investors looking for returns benefited from increases in overnight repo rates from January's single-digit basis points to the low teens to mid-20s. The rise in repo rates combined with managers' willingness to extend average maturities has contributed to a marginal rise in money market yields, analysts said."Clearly, investors and businesses are growing more comfortable with the course of events, not just in the United States, but in Europe," Deborah A. Cunningham, chief investment officer for the taxable money markets and senior portfolio manager at Federated Investment Management Company, wrote in an analysis published earlier this month."On an historical basis, the current inflation rate combined with improving economic fundamentals would indicate the federal funds target rate easily could be 1 percent, or even 2 percent, and still be considered very accommodative," she said. "Indeed, in any other environment, a 1 percent target funds rate would seem extremely low. Now, it would seem like nirvana."

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