Dollar-Funding Pressures Ease as Libor-OIS Gap at One-Year Low

Money-market forward indicators signaled strains in short-term dollar funding markets abated with the gap between where banks say the can borrow from each other and the Federal Reserve’s benchmark rate the lowest since August 2011.

The three-month London interbank offered rate, or Libor, which represents the rate banks say it would cost to borrow from one another, fell to 0.355 percent, adding to consecutive daily decline that began on Aug. 22. The Libor-OIS spread, a gauge of banks’ reluctance to lend, narrowed to 22.4 basis points, touching the least since August 2011.

Overnight index swaps, or OIS, give traders predictions on what 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.

Oversight of Libor will be handed to the U.K.’s financial regulator, and dozens of the currencies and maturities that make up the benchmark axed, under proposals published by Financial Services Authority Managing Director Martin Wheatley on Sept. 28. The overhaul is designed to revive confidence in a rate tarnished by scandal.

The British Bankers’ Association should be stripped of the responsibility for managing the rate and other organizations invited to replace it, Wheatley said in London the day the report was published. More than 100 Libor rates tied to currencies and maturities where there isn’t enough trading data to set them properly should be scrapped, and a code of conduct introduced for how lenders contribute to the benchmark backed by criminal penalties, he added.

Wheatley began his review at the request of Chancellor of the Exchequer George Osborne after Barclays Plc, Britain’s second-biggest lender, paid a record 290 million-pound ($470 million) fine in June for manipulating the London interbank offered rate, used to set rates for more than $300 trillion of securities.

The Wheatley changes will likely help trigger further declines in dollar Libor, according to companies including JPMorgan Chase & Co, TD Securities Inc. and Bank of America Corp.

Three-month dollar Libor may fall to 0.25 percent by January, a team of TD Strategists including Ken Silliman and Michael Lin, wrote in a note published on Sept. 28.

Predictions in the forward market for Libor-OIS, known as the FRA/OIS spread, were little changed at 20.2 basis points, according to the second rolling three month contracts. The gap is down from 58 basis points at the start of the year.

The difference between the two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, was little changed at 13.2 basis points. The gap, a gauge of investors’ perceptions of U.S. banking sector credit risk as swap rates are derived from expectations for dollar Libor, touched 11.25 basis points on Sept. 14, the lowest since March 2010.

Swap rates serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.

The seasonally adjusted amount of U.S. commercial paper fell $18.1 billion to $990.1 billion in the week ended Sept. 26, according to Federal Reserve data.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE