The reduced cost of emergency dollar funding signals the Federal Reserve and other central banks are concerned about the global banking system, according to Pacific Investment Management Co.’s Mohamed A. El-Erian.
The interest rate was reduced to the dollar overnight index swap rate plus 50 basis points, or a half-percentage point, from 100 basis points, and the program was extended to Feb. 1, 2013, the Fed said in a statement in Washington.
The aim is to ease strains in financial markets and “thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” a Fed statement said.
“I don’t think that is the main objective,” El-Erian, 53, Pimco’s chief executive and co-chief investment officer, said in a radio interview today on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “The real objective is they are seeing something in the functioning in the banking system that worries them and they are taking preemptive measures to relieve that pressure.”
While the stated goal of the program may help mollify policy makers and “the person in the street,” El-Erian said, the move is “a reaction to a break in the markets and central banks’ realizing that they need to move before this breakage becomes irreversible.”
Yields on 10-year Italian government securities remain above 7 percent, and 10-year German bund yields have climbed 20 basis points, or 0.20 percentage point, higher than U.S. Treasuries of the same maturity, signaling Germany’s waning status as a main refuge from Europe’s sovereign-debt crisis.
The cost for European banks to fund in dollars rose to the highest levels in three years today as concern the euro currency union may break up increased after leaders said they had failed to boost the region’s bailout fund as much as planned.
The central banks’ action “lowers the cost of emergency financing and increases the scope of emergency financing,” said El-Erian. “Central banks are moving in order to relieve pressure that they think either now or down the road may be really detrimental to the global economy.”
The Standard & Poor’s 500 Index surged 3.6 percent today, while a drop in U.S. Treasuries pushed the yields on benchmark 10-year notes up seven basis points to 2.06 percent.
Risk Asset Rally
The risk-asset rally may stall in days to come as more details come out to explain why the central banks undertook their actions, according to El-Erian.
“What has forced the hands of the central banks in such a dramatic fashion?” El-Erian asked. “We will get more about this in the next few days.”
Pimco’s $244 billion Total Return Fund (PTTRX), the world’s largest mutual fund, has returned 2 percent in the past year, lagging behind 80 percent of its peers, according to data compiled by Bloomberg. Over the past five years, the bond fund has returned 7.5 percent on average, topping 97 percent of rival funds. Pimco is a unit of the Munich-based insurer Allianz SE.
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