May 19, 2010 / 12:18 PM / in 8 years

MONEY MARKETS-Short-selling uncertainty adds to tensions

 * Benchmark euro, dollar interbank lending rates rise further
 * Confusion over implications of short-selling ban weigh
 * Swap spreads widen, other risk measures remain elevated
 By Kirsten Donovan and Umesh Desai
 LONDON/HONG KONG, May 19 (Reuters) - Key euro and dollar
interbank lending rates pushed higher on Wednesday, with
uncertainty over Germany's short-selling ban weighing on market
sentiment.
 The German move bans naked short-selling of euro-denominated
government bonds and shares in Germany's 10 leading financial
institutions, as well as related transactions in credit default
swaps, although market participants were still trying to work
out the exact implications of the move.
 The euro EUR= fell to a fresh four-year low, equity
markets tumbled and core German Bunds and U.S. Treasuries rose,
which in turn pushed swap spreads wider.
 "The reaction has been defensive, which tends to exaggerate
the tensions we've seen beforehand, so the result is the
opposite of what was probably intended," said Commerzbank rate
strategist Christoph Rieger.
 The September Libor/OIS three-month spread at almost 39
basis points remained double its level in mid-April, reflecting
those tensions.
 Two-year U.S. swap spreads -- a key gauge of financial
stress -- rose as much as 1.25 basis points to 40.25 basis
points USD2YTS=TWEB, having pushed out more than 10 basis
points from last week's lows.
 Tullett Prebon's head of G-7 economics Lena Komileva, said
concerns about risk trapped on bank balance sheets and fears
that policy intervention might leave the market long of
mispriced credit risk and short of a hedge were destroying
confidence at the same time.
 "Without confidence market efficiency will continue to
decline until liquidity trickles down to the bare minimum," she
said.
 "The growing disconnect between the ECB's liquidity actions
and Euribor rates already sends an alarm signal that policy is
no longer playing a corrective role for market systemic risk."
 Three-month euro Libor rates < EUR3MFSR=> fixed at four-
month highs of 0.635 percent, more than five basis points higher
than the all-time lows seen in early April despite excess
liquidity in the banking system having risen since then.
 Three-month Euribor rates EURIBOR3MD= also hit fresh
four-month highs.
 
 SHORT-SELLING BAN MAY PRESSURE SWAP RATES
 Pressures in the European banking and government bond
markets have left some banks holding paper which is virtually
impossible to discount or fund and so they have had to turn to
the European Central Bank for funds, albeit at a higher rate.
 To help Europe, the U.S. Federal Reserve last week
redeployed swap lines that give European firms access to
dollars.
 But in one sign some funding pressures may be easing, the
ECB received no bids for its latest offer of seven-day dollar
funds on Wednesday. 
 Analysts have said the funds are expensive at 1.22 percent
compared with rates in money markets.
 Three-month dollar Libor < USD3MFSR=> rose more than a basis
point to 0.4775 percent, the highest since the end of last July.
 Analysts said the ban on naked short sales of
euro-denominated government bonds could result in higher funding
rates as markets use interest rate swaps in place of
short-selling to hedge positions ahead of any future issuances. 
 "If you need to short government bonds to prepare for a bond
issue, the only way to hedge is to pay the interest rate swaps
instead of selling bonds," said Sean Keane, managing director at
Triple T Consulting. "LIBOR will start pushing up if people are
going to pay swaps." 

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