Benchmark interbank dollar funding costs fell to a fresh 2-1/2 month low on Tuesday on growing expectations the Federal Reserve might add extra cash to the system as soon as next week, keeping interest rates ultra low. The two-year US swaps spread - a gauge of financial market stress - fell to around 16 basis points, its lowest since late April, as the two-year US Treasury note yield hit an all-time low of 0.526 percent.
A Wall Street Journal report, without citing sources, said Federal Reserve officials meeting on August 10 would consider whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually.
Bond markets were already anticipating that the Fed would keep borrowing costs near record lows after Bernanke said on Monday that the economy has yet to recover fully and monetary policy must remain accommodative. The London interbank offered rate for three-month dollars fixed at 0.43469 percent, down one basis point from 0.44469 percent on Monday.
Its spread over the three-month Overnight Indexed Swap rate, another gauge of money market stress, was unchanged at 26 bps, the smallest gap since May 20. The steady decline in dollar loan costs since June has accelerated since Bernanke told US lawmakers last month that the economic outlook was "unusually uncertain". Rabobank, however, forecasts a move sideways in benchmark dollar interbank costs to 0.42 basis points in the next three to 6 months, saying markets might have gotten ahead of themselves pricing in the prospect of a double-dip in the US economy.
In euro money markets, three-month euro Libor fixed unchanged at 0.83156 percent while the equivalent Euribor rate inched up to 0.899 percent, matching its highest in a year set last week. The benchmark Euribor rate, which underpins longer-term borrowing costs in the wider economy and is set by a larger panel of banks than Libor, has risen around 11 basis points since the European Central Bank withdrew a month ago a huge chunk of emergency cash it provided to banks in 2009. Interbank costs have been climbing towards the central bank's 1 percent refinancing rate on the belief that the ECB will carry on scaling back its lending support in coming months, but the pace has slowed in recent sessions.