MONEY MARKETS-Excess reserves at Fed surge, dollar rates soft

* Fed balance sheet shows surge in excess bank reserves

* Effective Fed funds rate likely to drop below 10 bps

* Dollar lending stays soft in Asia, FRA spreads shrink

By Vidya Ranganathan

SINGAPORE, Oct 23 (Reuters) - Dollar lending rates in Asia were close to their all-time lows on Friday as forward rates markets priced in even tighter spreads and the Federal Reserve's balance-sheet showed U.S. banks holding record amounts of excess cash.

The Fed's balance sheet, released on Thursday, showed excess reserves that banks park with the central bank in the past week were on average $1.034 trillion, crossing the trillion mark for the first time ever [ID:nNYE002727].

The effective Fed Funds rate USONFFE=, the rate at which banks lend overnight to each other, has gradually been slipping within the zero-to-0.25 percent target band set by the Fed and is now at 0.11 percent.

With the Fed showing no intention yet of withdrawing its stimulus for the banking system or mopping up this excess liquidity, the effective overnight rate appeared set to head for single digits in basis points.

"Basically it's a signal that banks are still uncomfortable risking applying their funds to longer term duration or more risky assets. They simply want to keep in on call," said Sean Keane, a director of Triple T Consulting and formerly a money markets trader at Credit Suisse.

Excess reserves, amounts that banks in the United States place with the Fed at 0.25 percent over and above their mandatory reserves, haven risen over the past month after the U.S. Treasury reduced the size of its Supplementary Financing Program.

That programme allowed banks to invest in bills issued by the Treasury, but the Treasury was forced to scale it back as its debt levels approached a legal limit [ID:n16102200]. In this week's auction, the Treasury issued merely $15 billion of 42-day bills.

At the same time that the Treasury is winding down its operations to soak up cash, the New York Fed has been testing reverse repos, and getting systems in place to withdraw cash from the banking system when the need to do so arises.

Keane said the Fed wanted to ensure these huge amounts of excess cash with banks do not flood the wider economy and cause inflationary pressures when rates ultimately rise.

"The daily Fed Funds effective rate can sneak a little lower into the year end until the Fed start executing these reverse repos," said Keane.

"In the meantime, there is plenty of money sitting at the short end of the market and you could see the fed funds effective rate trade below 10 bps, which will be interesting to see in terms of the market reaction."

In Singapore, three-month dollar funding was quoted at an average 0.29 percent, close to its record lows and within ranges it has been at all month.

In dollar forward rate agreements (FRA) USIMFOSP=SMKR, front end contracts showed the spread between 3-month rates starting a month from now and the same tenor overnight indexed swap USDOIS was down to 12 bps, heading to lows below 12 seen in early September and thereafter to the lowest spreads for this year. (Editing by Tomasz Janowski)