The cost for banks to borrow three-month, unsecured dollar-based funds increased this week, posting the first weekly rise in 2012 as the positive effects of cheap central bank loans on funding levels appeared to taper off. The three-month dollar London interbank borrowing rate, or Libor, a benchmark for interest rate swaps and other products, was stable on Friday at 0.47365 percent, but ended the week higher after declining to 0.47355 percent a week ago.
The rate has fallen from over 0.58 percent at the beginning of the year, in large part driven by improved market liquidity since the European Central Bank first offered cheap three-year loans in December. "A large part of the initial decline was driven by excess liquidity introduced by the ECB," said Amrut Nashikkar, analyst at Barclays Capital in New York.
The ECB loans have shored up bank funding levels and reduced fears of cascading defaults as banks struggle with exposures to risky sovereign debt in the region and as investors including US money funds remain relatively cautious of lending to the area. The three-month dollar Libor rate remains much higher than the 0.25 percent area it traded at in mid-2011, before concerns about European bank health intensified.
Barclays' Nashikkar recommends entering into positions such as interest rate swap spread wideners to take advantage of any renewed tick in the rate. "When Libor was dropping there tended to be quite a bit of momentum, but since that has stabilised the market is more susceptible to widening in spreads," he said.
Two-year interest rate swaps, which are also used as a proxy for bank credit risk, tightened half a basis point to 25.25 basis points on Friday. They have tightened from over 30 basis points in late February and more than 50 basis points in early January.
Most Eurodollar futures contracts dropped on Friday to their lowest levels this year as Treasuries also continued their price decline, though the pace of the selloff was stemmed by some weaker-than-expected inflation data.