Money markets: cash squeeze fears rise as US deadlock drags on

Dollar funding costs for eurozone banks hit six-month highs on Friday and could rise to levels that may send lenders running to the ECB for greenbacks if the US fails to lift its debt ceiling. The European Central Bank's dollar swap line with the Federal Reserve is likely though to prevent a long-term cash squeeze and an escalation of interbank borrowing costs back to levels seen just after the Lehman Brothers collapse in 2008.
But panic could be the initial reaction if US politicians fail to reach an agreement before an August 2 deadline and the world's largest economy defaults on its debt. Markets are still expecting a last-minute deal. However, they are positioning for a US downgrade as ratings agencies have warned that such a move needs to be accompanied by a credible fiscal plan to reduce the country's debt burden.
Overnight borrowing rates in the repo market using Treasuries as collateral were last 24 basis points, up from 14 bps on Thursday and near zero levels earlier this month. Yields on August 4 T-bill rates rose 8 bps on the day to 24 bps, their highest since they were issued in February. The spread has been fairly steady mid-June through mid-July, but it has come down from highs of minus 12 bps seen at the start of May, before talk of a Greek debt restructuring gathered momentum. Those levels are still far away from minus 165 bps seen at the height of the Lehman crisis.