Money markets extend bets

Markets extended bets on Thursday on a eurozone interest rate cut, with analysts saying the latest bout of easing by the Federal Reserve and signs the Bank of England will follow suit left the European Central Bank looking behind the curve. Markets fully price in a rate cut in October and almost two by year-end, according to forward overnight indexed swap rates.
"The ECB in many ways moved too early to raise rates and now the market is clearly looking for a reversal by the ECB," said Credit Agricole rate strategist Orlando Green. However the ECB has only indicated it will not hike again soon and analysts say a policy reversal is unlikely next month.
The Fed warned on Wednesday of significant risks to the already weak US economy and launched a new plan to lower long-term borrowing costs, while the BoE opened the door to another round of asset purchases. "Dependent on monetary policy only, with what the BoE indicated and the Fed did yesterday, that brings the ECB clearly behind the curve," said Norbert Aul, rate strategist at RBC Capital Markets.
In longer-term financing markets, it is almost three months since a European bank launched a senior bond deal - the first rolling quarter without such a deal since at least 1999, Societe Generale said. "The ECB decision...to widen the collateral which banks can use...underscores the stress in the system and how they are tyring to help liquidity, particularly in the absence of swift fiscal responses to the sovereign crisis," Morgan Stanley strategists said.
The spread of three-month Libor rates over equivalent maturitiy overnight indexed swap rates - a measure of market stress - stood close to recent highs just below 80 basis point. In the dollar funding market, the three-month cross-currency basis - which widens as dollar funding strains rise - was close to its widest level since the 2008 financial crisis, at minus 113 bps, compared with around -90 on Monday. Markets will be watching if banks increase their take-up of three-month euro funds from the ECB next week, when 132 billion euros of loans mature.