Money-market indicators that traditionally warned of stresses in the financial system are being muffled by a deluge of central bank cash as the euro-region crisis focuses on Greece's future in the currency bloc and the meltdown of Spanish lenders.
The three-month cross-currency basis swap, the rate banks pay to convert euro interest payments into dollars, was 51.8 basis points below the euro interbank offered rate at 12:12 p.m. in London, from minus 50.3 basis points on June 15. The swap stayed in a range of 41.5 to 59.1 basis points below the benchmark in the past three months, even as an index of bank- bond risk surged 52 percent.
Concern that Greece's election result would hasten the country's exit from the euro and the deepening banking woes in Spain failed to clog up the plumbing of Europe's financial markets. That's because since December, banks that can't access money markets have been able to get as much cash as they need through the European Central Bank's 1 trillion-euro ($1.3 trillion) longer-term refinancing operations.
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"The political worries haven't been translated into spreads and the main reason for that is the ECB's LTRO," said Brian Jack, head of liquidity funds at Ignis Investment Services Ltd. in Glasgow. "There's a shrinking pool of top-tier banks money-market funds are willing to invest in, and thanks to the central banks those now have abundant liquidity."
The euro-dollar basis swap for three months was 157.5 basis points less than Euribor on Nov. 29, before the ECB pumped the new cash into the system. That was the most expensive cost since October 2008, in the depths of the global banking catastrophe that followed Lehman Brothers Holdings Inc.'s bankruptcy.
The one-year basis swap was 53.3 basis points below Euribor from minus 52.5 at the end of last week, according to data compiled by Bloomberg. The cost of that cross-currency exchange has also plummeted since December, when it reached 106.5 basis points less than Euribor, the most expensive in three years.
A gauge of the expected cost of interbank borrowing in euros in three months' time fell 43 percent since January. The FRA/OIS spread, which measures prices in the forward market for three-month Euribor relative to overnight indexed swaps, was 32 basis points, from 32.5 last week and 54.5 on Jan. 10.
Interbank Freeze
The ECB offered banks three-year loans for as much as they asked for, helping stave off a looming freeze in the interbank market, and teamed up with the U.S. Federal Reserve to ensure European lenders had access to dollars. The LTRO and dollar swap lines removed the threat of banks' funding drying up and a financial-system failure.
"Central banks are very, very concerned about what may happen," said Don Smith, a London-based economist at ICAP Plc, the biggest interdealer broker. "They will open the floodgates and flood the markets with liquidity. It will be very difficult to get a handle on risk in the money markets."
The increasing stresses that have been absent in most money-market measures are evident elsewhere in credit.
The Markit iTraxx Financial Index of credit-default swaps linked to the senior debt of 25 banks and insurers rose to 279 basis points at the end of last week, from 183 on March 19, according to data compiled by Bloomberg. The gauge snapped three days of declines to climb 2.5 basis points today.
Credit-default swaps typically fall as investor confidence improves and rise as it deteriorates. Contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals 1,000 euros annually on a contract protecting 10 million euros of debt.
The MSCI All-Country World Index of stocks dropped 7 percent since the beginning of May, tumbling to $305.6 last week. The index today climbed to $306.61, Bloomberg data show.
The Euribor/OIS spread increased to a three-month high of 43.6 basis points, from 40.9 on June 15. It's the first time the measure has broken out of its range of 37 basis points to 42 basis points since the end of March.
Another place where stress has been visible is the repurchase agreement — or repo — market, in which a bank or investor borrows money while putting up government bonds as collateral. Banks' preference for the shortest-term repos secured against top-rated securities has made it more expensive to borrow overnight than for three months.
The rate for a one-day euro repo rose to 17.2 basis points last week, the highest since March 12, compared with 11 basis points on three-month contracts, according to the EBF. The so- called inverted curve signals strain in bank funding.
Deposit Flight
Part of the reason for the tension in repo markets may be deposit withdrawal from banks in the euro area's periphery, according to Sandy Chen, an analyst at Cenkos Securities Plc in London. Greek banks have lost more than 30 percent of their total deposits since the end of 2009 as companies withdrew about 45 percent of their money, Bloomberg data show.
In Spain, total deposits have slipped 7 percent since peaking 12 months ago, while companies have reduced their deposits by 15 percent.
"Banks hit by withdrawals are often forced to sell the liquid assets they would've pledged as collateral for repo funding," said Chen. That process is magnified as balance sheets shrink and rating downgrades force more sales, which in turn reduces the impact of monetary easing by central banks, he said.
"It's questionable whether the Greek and Spanish banks would be able to fully participate" in another LTRO, "because a portion of their liquid assets would have been sold off to meet those deposit withdrawals," said Chen. "In the private repo markets, ratings downgrades would mechanistically drive a further shrinkage."
Central banks are continuing to pump money into the financial system to prevent them seizing up as Europe's woes worsen and U.S. economic growth slows.
Fed swap lines to foreign central banks surged to as high as $109 billion on Feb. 15 from $2.4 billion on Nov. 30, after the U.S. central bank and five counterparts joined forces to lower borrowing costs. The Fed lends dollars through the swaps to other central banks, which auction them to local lenders and give the Fed foreign currency as collateral.
The Bank of England announced June 14 it will activate a sterling liquidity facility to aid banks and plans to start a credit-easing operation that may boost lending in the economy by 80 billion pounds ($125 billion).
Interbank Loans
The rates banks say they pay for short-term loans from their peers are also falling in defiance of the deepening euro-region crisis. Three-month dollar Libor has remained little changed since the end of March and was at 0.468 percent today. That's the same rate it has been all month and compares with 0.583 percent on Jan. 5.
Three-month Euribor dropped to 0.659 percent from 1.418 percent on Dec. 19, while Euribor USD, a gauge of dollar funding costs compiled by the Brussels-based European Banking Federation, fell to 0.949 percent, from 0.989 percent April 11.
The 10 biggest U.S. money-market funds cut their holdings of debt issued by euro-area banks by $8.3 billion in May, Bloomberg data show. Holdings of debt from European banks, including those outside the euro area, have fallen every month since the end of January for a total decline of $20 billion to $178 billion.
Greece's two largest pro-bailout parties won enough seats to forge a parliamentary majority, official projections showed. The result eased concern the country is headed toward an imminent exit from the euro, while paving the way for weeks of horse trading with providers of its rescue cash and coalition talks between politicians.
New Democracy and Pasok won a combined 162 seats in the 300-member parliament, according to Interior Ministry projections with 99 percent of yesterday's vote counted.
Spain caused concern this month after it requested as much as 100 billion euros from the European Union to recapitalize its banks. The nation's debt burden prompted Moody's Investors Service to cut its credit rating by three steps to the cusp of junk status.
"Markets are just so scared by the vulnerabilities of the system, with very weak growth, low inflation and high debt," said ICAP's Smith. "When debt's so high you're very vulnerable to confidence and that's draining away."
Bloomberg
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