Finance and Markets | Financial news

Money markets fears mount over future bank funding stress

NEW YORK, May 18 Traders are starting to price in expectations of future bank funding stresses as concerns over a Greek exit from the euro zone increased fears that the rapid pace of bank withdrawals by Greeks could be replicated in Spain and Italy. Greeks are pulling cash from banks out of fear Greece might leave the single currency euro zone. Financial markets fear for the future of the entire currency zone, with Spain's banking sector also under pressure. As stresses in the region mount, some fear that banks may again need access to new, longer-term, cheap financing operations from the European Central Bank. The ECB, however, is not expected to offer new three-year loans, called Long-Term Refinancing Operations, unless the situation worsens. "Most people think that given the signs we've seen from the ECB so far, it would take a significant increase in risk for them to do another LTRO," said Amrut Nashikkar, an analyst at Barclays in New York. The ECB's December and February LTROs pumped almost 1 trillion euros of three-year cash into the banking system. "The feeling is that they won't come in until things blow out, and that's why the market is pricing in that blow-out," Nashikkar said. The benchmark three-month London interbank offered rate has fixed at approximately 47 basis points since the beginning of April. Futures contracts, however, are pricing in an expectation that the rate could increase to around 60 basis points by September. That would exceed the highs of around 58 basis points reached late last year before the ECB did the first LTRO. Longer-dated swaps that allow banks to swap euros for dollars are also showing an increased risk that banks could struggle to obtain dollar funding. The premium charged to swap euros to dollars for two years has increased to 73.5 basis points, from around 60 basis points a week and a half ago and is trading at its highest level since mid-January. The premium to make the exchange for three-months , however, has changed less at around 55 basis points versus 50 basis points a week and a half ago and is trading at its highest level in around a month. Some analysts, meanwhile, say another LTRO will be necessary if bank depositors in Spain or Italy pull funds at the same rates as seen in Greece. Greek bank deposits have fallen almost 30 percent since the start of 2010, according to ECB data, and Societe Generale said a similar outflow in Spain or Italy could create funding gaps of 140 billion to 280 billion euros in Spain and 200 billion to 400 billion euros in Italy. "As deposit outflows outpace de-leveraging, we need another 1 trillion euro LTRO," the bank's strategists said.

Money markets greek tensions risk reigniting dollar funding stress

* ECB's liquidity measures ease dollar funding strains* Uncertainty over Greece could increase stress levels again* Euro rates to remain low on February LTRO prospectsBy Marius ZahariaLONDON, Jan 18 A key measure of dollar funding strains for euro zone banks hit its lowest level in four months on Wednesday on the back of a recent liquidity boost from the European Central Bank but uncertainty over a Greek debt deal risks halting that easing. Debt refinancing worries for euro zone banks eased after they borrowed almost half-a-trillion euros from the European Central Bank late last year and the improvement in sentiment has filtered through to dollar funding markets as well. A cut in the cost of using the dollar swap line that the ECB has opened with the U.S. Federal Reserve has also contributed to the fall in interbank dollar lending rates. The three-month euro/dollar cross currency basis swap , which tightens when lenders charge less for swapping euro interest payments on an underlying asset into dollars, narrowed to minus 82 basis points, a level last seen in mid-September. This compares with minus 167.5 bps hit in late November which was the widest in three years."It's a function of ECB liquidity measures, which are reducing stress in money markets," said Chris Walker, currency strategist at UBS.

However, there are growing tensions around talks between Greece and its private creditors aimed at avoiding a default, and traders warn that could counter the effects of the additional liquidity. The talks resumed on Wednesday. Some banks still find it hard to secure dollar liquidity and had to tap the ECB's one-week dollar tender on Wednesday. Fourteen banks borrowed $5.89 billion in the auction, compared to 15 banks taking $5.72 billion in the previous week."The improvement in the (tighter) euro/dollar basis swaps is just in the price ... The U.S. (dollar) market is still closed for these banks," said ING rate strategist Alessandro Giansanti.

"If no agreement will be reached in Greece and we move closely to a disorderly default I would expect the basis swap to rewiden again."Benchmark three-month dollar interbank Libor rates also inched lower to 0.56120 percent from Tuesday's 0.56230 percent. CASH BONANZA Most of the extra cash the ECB has pumped into the system is returning to the central bank via its deposit facility, meaning that it is not put at work, leaving the interbank markets frozen and the shrinking real economy scarcely financed.

Lenders parked an all-time high of 528 billion euros with the ECB on Wednesday, up from 502 billion the previous day. Changes to the ECB's rules that require banks to keep less of a cash buffer with the central bank enter into force with the start of a new reserve maintenance period on Wednesday and are estimated to leave an extra 100 billion euros in the system. The extra liquidity may end up in the deposit facility as well, unless banks decide to borrow less at the ECB's cash tenders. However, on Tuesday, banks took 127 billion euros in one-week funds, more than expected by traders in a Reuters poll and 16 billion more than the week before. The huge excess of cash in the system is expected to keep overnight Eonia rates within a 35-45 bps range in the next month, analysts say. In Eonia forwards market, Societe Generale strategists see an opportunity to receive February Eonias and pay January, as they consider the 1.5 bps spread between them too small due to plans for another three-year cash injection in February and a "non-zero probability" that the ECB will cut rates next month. But they added that trading opportunities in the Eonia space are few due to the excess cash in the market. There was more value in bets that spreads between forward Euribor rates and forward Eonia would tighten, they said, "given that they have lagged so much relative to peripheral spreads, although the ECB has greatly reduced ... liquidity risks."On the other hand, RBS has recommended earlier this year to bet against the tightening on the view that the ECB's liquidity boost only solved a short-term liquidity problem for banks and not the underlying stress factor in the banking sector, which is the sovereign debt crisis.

Money markets interbank rates extend slide but activity tame

Benchmark interbank lending rates maintained their downward trek on Wednesday driven by the huge cash boost from the European Central Bank but activity remained subdued as banks looked for gains in higher-yielding assets. Most measures of money market stress were stable as the one trillion euros of low-cost three-year liquidity the ECB has pumped into the banking system over the last two months provided a shield from ongoing uncertainty over the outcome of Greece's debt swap deal with private creditors. The hefty cash infusion has driven the rates at which banks lend to each other to their lowest levels in 17 months and lessened the urgency for banks to raise money in the open market."Liquidly is available in large sizes. However, there's not a lot of additional volume going through he interbank market yet. I guess people who are long cash might be investing in European sovereign debt as the yield is more attractive than interbank rates," a money markets trader said."As we go along I would expect some improvement. For now in the short end no-one needs to raise anything so volume is down and in the terms everyone may be trying to get better yield in other asset classes than interbank trading."

Peripheral euro zone bond markets, notably Spain and Italy, have benefited from the cash injection as their banks have used the cheap loans to buy sovereign bonds, driving yields especially on shorter-dated debt to multi-month lows. Banks took 530 billion euros in the second dose of cheap central bank money last week after gorging on 489 billion euros in December, and the liquidity is expected to push bank-to-bank lending rates close to the record low of 0.634 percent seen in March 2010. Three-month Euribor rates, traditionally the main gauge of unsecured interbank euro lending, fell to 0.911 percent from 0.920 percent, the lowest level since September 2010. Equivalent Libor rates fixed by a smaller panel of banks also fell.

The three-year cash injection from the ECB has pushed excess liquidity in the money market to 803 billion euros according to Reuters calculations. Shorter-term one-week rates, the most heavily influenced by the level of cash in the system, ticked down to 0.320 percent from 0.323 percent, while overnight rates fell to 0.342 percent from 0.351 percent the previous day.

The three-month lending rates have already dropped by over a third since the ECB announced plans to lend banks three-year money back in December, but are still well above the low of 0.634 percent they hit in early 2010. But the market believes that rates may fall even further than in 2010 as banks are awash with cash, and will be for a long time."With so much excess liquidity in the system, we expect EONIA to continue to trade at an approximate 10 basis point spread to the (ECB) deposit facility and for Euribor fixings to continue drifting lower as tail funding risks have receded," said Elaine Lin, a rate strategist at Morgan Stanley. The glut of cash is keeping short-term market rates well below the ECB's main 1 percent policy rate. Instead the bank's 0.25 percent overnight deposit rate is acting as a floor for market rates. Euribor futures showed markets were anticipating three-month rates to fall to 0.705 percent by June, with a further drop to 0.655 percent by September.

Money markets longer term rates seen low for a prolonged period

Investors dissatisfied with short-term interest rates of close to zero are increasingly seeking derivative instruments carrying longer maturities, taking the risk of a sudden shift in central bank policy. Record low official European Central Bank interest rates and excess liquidity in the euro zone system of 750 billion euros, according to Reuters calculations, have pushed money market rates to record lows. Speculation that the ECB could cut its deposit facility rate below the current zero percent, meaning investors would pay a fee to park their money, is putting even more pressure on rates. The overnight euro interbank rate, Eonia, last fixed just below 0.1 percent. Forward financial contracts that represent bets on where Eonia is going to settle at certain points in the future see the rate below 0.1 percent for the next two years.

Searching for higher returns, investors are moving towards longer duration. This week, for instance, the four-year Eonia narrowed by 10 basis points to 0.40 percent."Generally what we are seeing is that because you get next to nothing in the front end, people are willing to take on more risk and switch to longer durations," one trader said. Commerzbank rate strategist Christoph Rieger recommends bets that the 1y1y Eonia forward -- a financial product that targets the level of a one-year Eonia contract starting in one year's time -- will fall to last month's lows of just above 10 bps from around 20 bps.

"Even if the ECB does not cut the depo rate further, which remains our base case, prospects of unchanged rates, abundant excess liquidity and potentially lower EONIA-depo spreads should be enough reasons to expand into this part of the curve," he said in a note. Societe Generale rate strategist Ciaran O'Hagan believes it makes sense to place similar bets even further out on the curve, even if the time period goes beyond the massive three-year cash injections made by the ECB last December and in February.

The main risk investors are taking is a possible pick-up in the global economy that could prompt central banks to reverse or discontinue some of their more radical experiments in monetary policy easing. But given the state of the world's major economies and the depth of the euro zone debt crisis, investors seem willing to take the risk."Central banks around the world are going to continue to provide liquidity," O'Hagan said. "The long-term challenges we're facing are so severe and so dramatic that at the moment this is how you want to be positioned."I'm not saying that you can't reverse these positions in a few months, but certainly for now you do want to be positioned long OIS (overnight index swaps)," he said, referring to trades in which market players position to receive overnight rates in the future via Eonia-based derivative products.

Money markets repo rates dip in fed rate cut speculation

repurchase agreements fell for a second day on Wednesday as investors mulled whether the Federal Reserve might eventually follow the European Central Bank and cut the interest it pays on excess reserves. The rate on repos secured by Treasuries was last quoted at 21 basis points, down from 27 on Monday, and the lowest since June 19. The rate has dipped amid some speculation the Fed may eventually cut the interest rate it pays on excess reserves to banks (IOER). The speculation was spurred after the ECB on July 5 cut to zero the deposit rate it pays banks for parking money with it overnight."Because of the uncertainty over IOER, if you are an asset manager and you are taking money out of other markets you are probably going to put that into overnight repo, so it is going to drive the rate lower," said Thomas Simons, money market economist with Jefferies & Co in New York. The IOER currently stands at 0.25 percent. Some investors believe the Fed might reduce the rate in order to encourage other types of lending and possibly prop up economic growth.

Fed Chairman Ben Bernanke, in testimony before the Senate Banking Committee on Tuesday and Wednesday, offered few new clues on whether the U.S. central bank was moving closer to a fresh round of monetary stimulus, but repeated the Fed's pledge to act if needed. Meanwhile euro zone bank-to-bank lending rates fell to all-time lows on Wednesday, driven down by record low ECB interest rates and the decision to stop paying interest on money deposited at the central bank overnight. The ECB's overnight deposit rate of zero acts as a floor for money market rates because banks lend to rivals only if they are able to earn a better rate of interest than at the central bank.

The ECB hopes its unprecedented move, which means banks now get nothing if they park their spare cash there, will nurture a return to more significant interbank lending by forcing banks to look for more profitable options. Although some money market experts fear the cut could backfire and kill off parts of the market, the move, plus a growing belief the ECB could continue to cut rates, has had an immediate impact on bank-to-bank rates. Three-month Euribor rates, traditionally the main gauge of unsecured bank-to-bank lending, hit an all-time low of 0.464 percent on Wednesday, down from 0.470 percent. The equivalent Libor rate, also at a record low, fell by 1 basis point to 0.34464 percent. Libor is set by a smaller panel of London-based banks.

Overnight rates bucked the trend rising to 0.119 percent from 0.114 percent. However, they remain 20 basis points below where they were before the ECB cut rates. Dollar-priced three-month bank-to-bank Euribor lending rates fixed lower at 0.919 percent, while overnight dollar rates dipped to 0.33857 percent from 0.33929 percent. Euribor rates, like counterpart Libor bank-to-bank rates , are currently under investigation after it emerged a number of banks were falsely submitting the Libor rates they pay. Banks transferred almost half a trillion euros from the ECB's deposit facility to their current accounts at the central bank when its zero deposit rate came into force last week. But with the monthly reserves cycle now in its stride and fewer options available for banks to juggle their funding, the money has now started to trickle back again. A total of 382 billion euros was parked in the ECB's deposit facility overnight. Moving in the other direction, the amounts in banks' current accounts dipped to 490.8 billion euros.

Money markets spanish turmoil may revive bank funding fears

* Short-term funding trouble may return to dog Spanish banks* Investors fret over source of bank recapitalisation cash* Banks still shut out of funding market, repo cost may riseBy William JamesLONDON, May 10 Spanish banks could face fresh funding problems if plans to recapitalise the financial sector fail to convince investors it can withstand continued heavy losses on property loans. Spain effectively nationalised Bankia, its fourth-biggest lender, on Wednesday in an effort to stall a four-year-old banking crisis, and is expected to outline further measures to shore up the system on Friday. Financial sources told Reuters that Spain plans to force banks to set aside an extra 35 billion euros against loans made to the building sector, in addition to the 54 billion euros already set aside for this year. But, with most Spanish banks unable to raise fresh capital from spooked investors, the prospect of further cash from already strained public coffers has done little to assuage concerns and access to vital funding markets has seized up. The European Central Bank countered a previous funding freeze by offering three-year loans to banks. Analysts say Spanish banks borrowed enough to cover redemptions for 2012. But that relief is already waning and the latest crisis of confidence over long-term solvency is threatening banks' ability to resume normal funding when the ECB-bought calm runs out, and to cut off access to cash through the widely-used repo market.

"The problem is that liquidity doesn't fix solvency. This is a capital issue," said Alberto Gallo, head of European macro credit research at RBS."You can make the patient survive with life support and anesthesia but eventually you need to do surgery which includes recapitalisations, and potentially cutting out some of the bad parts of the system which are insolvent."FUNDING FREEZE

Spanish banks were able to dip a toe in the funding markets earlier this year with a flurry of debt issues, but that window seems to have slammed shut."(The market) is closed to them completely... the funding costs are just too high and they just wouldn't get a deal away; that's the bottom line," said Suki Mann, credit strategist at Societe Generale in London. The ECB has shown no willingness to offer banks more cash, meaning they will eventually need to return to investors. It may take more to unlock market access than forcing banks to acknowledge potential losses and injecting fresh capital, with investors doubtful about where that money will come from. Spain's shaky public finances have triggered a selloff in its bonds. This in turn hits the domestic banks that hold much of the debt. If recapitalising banks further strains the budget the positive effect of the new capital could be quickly diluted.

SOVEREIGN-BANK FEEDBACK Rating agencies have expressed concern over the burden banks put on Spain's creditworthiness, and cuts to individual banks' ratings may stir up more problems. Spanish banks still use repurchase (repo) markets, using government bonds to raise short-term cash, but further rating downgrades could threaten that important sources of finance. Most Spanish banks use clearing houses to reduce the risk and cost of repo trades. Current rates are around 30 basis points but the cost could rise sharply if credit ratings slip. ICAP estimates a downgrade to BBB- would double the 'initial margin' amount clearers require to offset risks, while a cut to BB+ would triple that cost. This would probably increase dependence on the ECB, add to uncertainty in the market and reinforce the sovereign-bank feedback loop that is threatening Spain's fiscal stability."(Banks) need to have access to market funding, both in long-term and short-term markets. It would be an enormous strain on the ECB and investors would be hugely unnerved by the fact that a bank cannot access funds from the market," said Don Smith, an economist at ICAP.