Derivatives Signal Rising Money Market Stress as Greece Worsens

Forward markets signaled increased stress in the money markets as traders lifted bets for the gap between the London interbank offered rate and Federal funds for the months ahead amid concern a Greek failure to form a government may force the nation to exit the euro area.

Predictions in the forward market for Libor-OIS, a gauge of banks reluctance to lend, rise to a four-month high, according to the so-called FRA/OIS spreads. Predictions for the spread for the three month period beginning in September, the so-called second rolling contract, was 43.9 basis points, compared with 41 basis points on May 11 and as narrow this year as 28.8 basis points on March 2.

The difference between the two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, widened 2.2 basis points to 36.88 basis points, the most since January. The gap is a gauge of investors’ perceptions of U.S. banking sector credit risk as swap rates are derived from expectations for the dollar three-month London interbank offered rate, or Libor. Swap rates serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.

Three-month dollar, which represents the rate at which banks say it would cost to borrow from another, was 0.46585 percent, down from 0.46685 percent on May 11, according to the British Bankers’ Association.

The Libor-OIS spread was little changed at 31.3 basis points. Overnight index swaps, or OIS, give traders predictions on where the Fed’s effective funds rate will average for the term of the swap. The central bank’s target rate is set in a range of zero to 0.25 percent.

Euribor-OIS Spread

The cost for European banks to convert euro-denominated payment streams into dollars-based funding via the cross currency swaps market increased. The three-month cross-currency basis swap was 46.9 basis points below Euribor, compared with 45 below on May 11.

The seasonally adjusted amount of U.S. commercial paper surged $26.4 billion to $966.4 billion outstanding in the week ended May 9, according to Federal Reserve data. During the two week period ended May 9, the market has expanded $40.5 billion, the biggest increase since $40.8 billion for the comparable period ended May 25, 2011, according to Fed data compiled by Bloomberg.

The Euribor-OIS spread, the difference between the euro interbank offered rate and overnight indexed swaps, narrowed. The measure of banks’ reluctance to lend to one another was 37 basis points from 38 basis points on May 11. The measure has fallen from 95 basis points at the start of the year.

Basis Swaps

The price on one-year cross-currency basis swaps between yen and U.S. dollars was minus 31.2 basis points, compared to minus 30.3 at the end of last week. A negative swap price indicates investors are willing to receive reduced interest payments on the yen they lend in order to obtain the needed financing in dollars.

Foreign-exchange swaps are typically for periods of less than a year, while cross-currency basis swaps usually range from one to 30 years. The latter are agreements in which a person borrows in one currency and simultaneously lends in a different currency. The trade involves the exchange of two different floating-rate payments, each denominated in a different currency and based on a different index.

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