LONDON -- Dollar money market strains eased again on Wednesday, as recent action by the U.S. central bank to boost dollar liquidity throughout the financial system helped bring down interbank lending rates and narrow spreads .
All main three-month London interbank offered rates — dollar, euro and sterling Libor — fell on Wednesday, although the premium for sterling Libor over Overnight Index Swaps rates rose by almost five basis points.
Money market traders appear to have given the Federal Reserve's latest tweaks to its Term Auction Facility (TAF) operations the thumbs up.
The Fed said last week it will increase the size of the TAFs and extend their availability, as well as widening the scope of collateral it will accept for loans under the separate Term Securities Lending Facility program.
On Tuesday the Fed held a $75 billion TAF auction for 28-day funds, which drew a bid-to-cover ratio of 1.29. The stop-out rate was 2.22 percent, sharply below Wednesday's one-month dollar Libor of 2.62125 percent and the 2.87 percent rate at the TAF auction two weeks ago.
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"With (Tuesday's) TAF auction in the U.S., the fact that it didn't have as many bids as people thought might come in seems to have given a bit of a breather to peoples unease in the U.S. Libor market," said one trader in London.
Three-month dollar Libor fell over two basis points to 2.73438 basis points , the British Bankers Association's latest daily fixing showed. That's the seventh consecutive daily decline.
Three-month Libor/OIS dollar spreads narrowed by almost two basis points to around 75 basis points, the tightest in almost a month.
STERLING STRESS RETURNS
Another notable development in money markets on Wednesday was the second day in a row sterling Libor/OIS spreads have widened. That happened even though nominal three-month sterling Libor fell again, and has indeed fallen every session bar one since April 14.
Traders say this is down to the sharp fall in sterling OIS rates, which reflect a growing risk this week that the Bank of England will cut interest rates on Thursday.
Service sector and manufacturing data this week have been much weaker than expected, pushing interest rate traders to price in an almost 50-50 probability of a cut.
If the BoE does ease, it will be its first back-to-back rate cut since the end of 2001.
"Our central case is for an on-hold decision from the BoE but we'd (very subjectively) put about a 40% probability on a rate cut at this meeting," Morgan Stanley said in a note.
"Weakness in much of the recent economic data might suggest to some MPC members that further 'insurance' is required against a worse-than-expected outcome for UK growth."
Strategists at JP Morgan noted that: "Since the recent peak of 5.54% on 25 April, UK 2-year swap yields have fallen over 20bps."
Three-month sterling Libor fell below 5.80 percent for the first time in almost two months but the Libor/OIS spread widened to around 96 basis points, the widest in a couple of weeks.
The widening out of spreads this week looks to have fizzled out the positive impact on sterling money markets from the BoE's recent liquidity-boosting measures.
Last month, it unveiled a 'Special Liquidity Scheme' worth 50 billion pounds or more which will allow banks to swap illiquid assets for government bills, making it easier for them to raise much-needed cash to repair balance sheets and perhaps lend out again.
Euro money markets, meanwhile, showed slight signs of easing. But nominal Libor hovered close to the highest levels of the year and spreads near their widest of the year.
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