US SWAPS-Bailout hopes deflate spreads, but quarter-end looms

*Hopes of bailout passage narrows swap spreads

*2-year spread ends over 20 bps from record wide

*Quarter-end cash needs seen keeping dollar Libor high

(Updates market action, adds quotes)

By Richard Leong

NEW YORK, Sept 24 (Reuters) - A closely watched gauge of
short-term U.S. interest rate risks fell on Thursday, as signs
of an imminent bailout of the U.S. financial sector raised
hopes of calm returning to credit markets.

But the expected quarter-end scramble for cash should keep
market interest rates high and crimp available funds for the
interbank market, analysts said.

"The extreme fears in the funding market has subsided
somewhat," said Josh Stiles, senior bond strategist at
IDEALglobal in New York.

U.S. lawmakers seemed to be on the brink of a final
agreement on the Troubled Asset Relief Agreement (TARP), less
than a week after it was introduced by U.S. Treasury Secretary
Henry Paulson and backed by Federal Reserve Chairman Ben
Bernanke. For more details, see [ID:nSP335584]

The cost to exchange two-year fixed-rate interest payments
for floating rates in the interest rate swap market fell 138.75
basis points in late trading.

The spread or risk premium on two-year swaps over
comparable Treasuries, which falls with decreasing stress on
credit markets, hit a record wide of about 163.00 basis points
on Wednesday.

Ten-year swap spread finished at 67.75 basis points fromm
75.25 basis points late Wednesday.

A sustained narrowing in swap spreads spells lower
borrowing costs for companies and consumers.

ANOTHER HURDLE

The $700 billion federal rescue package should help
stabilize money markets, which have been in upheaval for than a
year. But the short-term credit markets face a major hurdle in
the near term, some analysts said.

Cash needs at a number of banks and financial companies
will likely intensify as the third quarter comes to a close
next Tuesday. This could push interbank lending costs, measured
by London Interbank Offered Rates (Libor), even higher in the
coming days, they said.

Libor on dollar funds jumped on Thursday. Three-month
dollar Libor USD3MFSR=, the floating-rate benchmark on
interest rate swaps, was fixed at 3.76875 percent, up nearly 30
basis points late Wednesday. For more, see [ID:nLP648832]

On top of quarter-end pressure, there will be a "year-end
turn" on three-month Libor. This is when the three-month
interbank rate will reference to expected higher borrowing
costs in the first quarter of 2009.

But one analyst reckoned financial companies have hoarded
enough cash this week to survive quarter-end and the year-end
turn.

"This year-end turn could be a cakewalk," said Duncan
Balsbaugh, senior market strategist at IFR Markets in Boston.

(Reporting by Richard Leong)