Indicators Signal Higher Money-Market Stress Amid Europe Crisis

Money-market forward indicators signaled strains in short-term funding markets increased amid the deteriorating credit conditions of European sovereign borrowers.

Predictions in the forward market for London interbank offered rate-OIS, a gauge of banks’ reluctance to lend, rose to an almost one-week high, according to the so-called FRA/OIS spreads. The forecast by the spread for the three-month period beginning in September, the so-called second rolling contract, reached 40.1 basis points, the highest level since May 24, compared with 37.3 basis points yesterday.

Three-month Libor, which represents the rate at which banks say it would cost to borrow from another, was 0.46685 percent, where it has held since May 16, according to the British Bankers’ Association. The Libor-OIS spread, a gauge of banks reluctance to lend, narrowed to 30.2 basis points from 30.7 basis points.

Overnight index swaps, or OIS, give traders predictions on where the Federal Reserve’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.

The gap between the two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, widened 2 basis points to 35.17 basis points. The gap is a gauge of investors’ perceptions of U.S. banking-sector credit risk as swap rates are derived from expectations for dollar Libor. Swap rates serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.

Cross Currency Swaps

The cost for European banks to convert euro-denominated payment streams into dollar-based funding via the cross currency swaps market increased. The three-month cross-currency basis swap was 50.9 basis points below Euribor, compared to 47.2 basis points below yesterday.

The Euribor-OIS spread, the difference between the euro interbank offered rate and overnight indexed swaps, held steady. The measure of banks’ reluctance to lend to one another was little changed at 39 basis points. The measure has fallen from 95 basis points at the start of the year.

The seasonally adjusted amount of U.S. commercial paper rose $14.9 billion to $1.009 trillion in the week ended May 23, according to Fed data. That’s the highest level since $1.03 trillion on Sept. 21, while the fourth straight weekly increase is the longest streak since the period ended Feb. 8.

The price on one-year cross-currency basis swaps between yen and dollars was minus 37.2 basis points, from minus 36 basis points yesterday. 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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