Money market tensions eased on Wednesday after the world's major central banks stepped up measures to keep funds flowing through the financial system and stave off a potential credit crunch stemming from the eurozone's sovereign debt crisis. The US Federal Reserve, the European Central Bank and the central banks of Canada, Britain, Japan and Switzerland said in a joint statement they had agreed to lower the cost of existing dollar swap lines by 50 basis points from December 5.
It was already looking cheaper for European banks to take dollars from the ECB next week rather than the market, where they have been struggling to access dollars. The move makes the December 7 tender more attractive, which could boost demand. The premium to banks of obtaining dollars in the market fell, as reflected by euro/dollar cross-currency basis swaps, which narrowed across the three-month to one-year curve.
Three-month basis swaps narrowed 30 basis points to minus 131 bps while one-year was 18 bps tighter at 90 bps but still near levels last seen in October 2008 in the aftermath of Lehman Brothers' collapse. Eurozone interest rate futures rallied across the 2011/2012 curve, driving implied rates down, while German two-year government bond yields hit a new euro-era low of 0.276 percent, aided too by expectations that the ECB will cut interest rates next week.
Although three-month dollar loans from the ECB would be cheaper, with the rate falling to 0.71 percent from December 5 from 1.45 percent, RBS and Citi strategists noted that the cost of collateralised borrowing was still higher than dollar Libor. The ECB collateral requirement also remained unchanged with respect to foreign currency-denominated collateral. London interbank offered rates (Libor) for three-month dollars rose to 0.52889 percent from 0.52694 percent on Tuesday, according to the latest fixings by the British Bankers' Association. The fixings came before the announcement of the central banks' action.