May 14, 2018 / 10:04 PM / a year ago

Key U.S. funding cost falls with Treasury cash pile

NEW YORK (Reuters) - After months of rapid increases that set off alarm bells in global markets, a key measure of U.S. borrowing costs fell by the most in nearly eight years over the last week as the U.S. Treasury dialed back its hefty short-term paper issuance.

Libor, or the London Interbank Offered Rate, was set on Monday at 2.33 percent for its closely tracked three-month term USD3MFSR=, the lowest since early April. A benchmark for $200 trillion worth of U.S. financial products, it has now fallen nearly 4 basis points in the past five days, the most over any comparable run since August 2010.

The respite comes as the U.S. government eases up on the massive volume of Treasury bill sales that many analysts and investors blamed for Libor’s quick run up over the previous several months.

“It’s down because bill supply is down,” said Aaron Kohli, interest rates strategist at BMO Capital Markets in New York. “They are cutting bill supply and that’s like handing investors money.”

In the first quarter, Libor had risen by more than 60 basis points, twice the pace of increases in other rates that track Federal Reserve interest rate policy, such as the overnight indexed swaps, or OIS, market.

The widening gap between Libor and OIS, which grew to its largest since 2009, had concerned some market participants who worried it was a warning sign of financial stress, while others argued it would start to normalize after the flood of T-bills had washed through. It has narrowed by almost 15 basis points over the past month.

To build up cash in part to fund annual income tax refunds, the Treasury ramped up bill issuance during the first quarter, effectively crowding out banks and forcing them to increase their rates to remain competitive. But with that deadline now passed, it has tapered that in the last few weeks.

In March, for instance, the Treasury sold a combined $161 billion in one-month, three-month and six-month T-bills for four consecutive weeks. This compares with $135 billion set for auction this week.

At the end of April, the Treasury had $419.38 billion of cash on hand at the Federal Reserve. By last Thursday, it had dropped to $338.24 billion.

With less T-bill supply, investors could deploy more of their cash into commercial paper and other short-term debt issued by banks and other companies, lowering their borrowing costs to finance trades, inventories and payrolls, analysts said.

Kohli and other analysts cautioned Libor could well pick up again later this year when federal debt issuance ramps up once more to fund a growing budget gap as a result of the massive tax overhaul in December and a two-year spending agreement inked in February.

The volatility in Libor comes as uncertainty has been on the rise over its planned phase-out after 2021. Moody’s Investor Service on Monday said the lack of clarity over whether alternative measures promoted by regulators such as the Fed would come to dominate the market was a potential negative for credit markets.

“The essential issue for financial market participants is that creditors will hold contracts that no longer ‘work’ as expected when Libor is retired,” Moody’s senior vice president Simon Ainsworth said in a statement on Monday.

Reporting by Richard Leong; Editing by Dan Burns and Tom Brown

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