/ 6 October 2008

Money market squeeze eases but fears persist

A squeeze on dollar funding has eased in Asia after massive cash injections by central banks, but reluctance to lend to South Korean banks underscored jitters about the global economic outlook despite the US Congress having approved a $700-billion rescue plan.

The Bank of Japan said on Monday it offered to lend one-trillion yen against pooled collateral in an auction to inject liquidity into the market.

Central banks across the globe have injected billions of dollars into money markets in the past few weeks as the financial turmoil led commercial banks to hoard cash, instead of lending to each other.

The cost of overnight dollar funding in Asia held steady between 2% and 3% on Monday after last week’s easing in rates as commercial banks appeared to be more willing to lend to each other as policy makers tried to tackle the financial crisis.

The cost of dollar funding shot up to 10% in Asia last month — five times the Federal Reserve’s benchmark interest rate — when Lehman Brothers’ collapse sparked a resurgence in the year-old global credit crisis.

India’s local currency overnight cash rates fell to 11% on Monday after hitting as high as 17,5% last week.

The US Congress approved a $700-billion plan to bail out the financial sector, but concerns over how quickly it would be implemented and whether it would be enough to shore up the economy left investors seeking safety in US and Japanese government bonds.

Germany offered on Sunday a blanket bank deposit guarantee as it clinched a deal to rescue lender Hypo Real Estate, while officials across the globe are scrambling to contain the fallout from the deepest financial crisis since the 1930s.

South Korean banks struggle
South Korea’s finance minister said on Monday the government would use the official foreign reserves to help banks, which faced difficulties in securing enough foreign-currency liquidity.

But the yield on South Korea’s three-month certificate of deposit rates which local banks sell to raise short-term cash, still rose to 5,90% on Monday, the highest level since May 2001.

”Although we are not expecting a banking crisis in Korea, the credit crunch is likely to be most severely felt in Korea among Asian economies given the highly leveraged Korean corporate and households,” analysts at UBS said in a note.

The cost of protection against a default in South Korea’s sovereign debt remained little changed at 240 basis points, its five-year credit default swap showed An investor would thus need to pay $240 000 annually for protection against $10-million in South Korea’s sovereign debt.

South Korea’s CDS has risen six-fold this year and is now significantly more expensive than similarly-rated Malaysia, which was trading at about 180 basis points on Monday.

Meanwhile, Indonesia’s central bank said on Monday that it may soon announce revisions on the minimum reserve requirements for commercial banks in a bid to maintain market liquidity.

Pressure on rates
In the course of a hectic weekend, leaders of Europe’s four biggest economies — Germany, France, Britain and Italy — decided against a coordinated bank bailout, while vowing to stabilise markets.

Three-month London Interbank Offered Rates for US dollars rose 13 basis points on Friday to 4,33%, painfully far above the Federal Reserve’s 2% cash rate.

The spread between LIBOR and average expected fund rates hit another new record around 288 basis points, indicating banks were unwilling to lend to each other and hoarding cash at all costs.

But analysts believe pressures are mounting for central banks to cut interest rates to help struggling banks and businesses.

”Significant global easing of financial policies is now the baseline scenario, which increases the likelihood of turnaround in risky financial assets,” Tim Condon, head of Asia research at ING, said in a note.

Last week, the European Central Bank left its benchmark rate on hold at 4,25% but it highlighted the risk to the European economy from the financial crisis.

UBS expects the Federal Reserve to halve its key interest rate to 1% by the end of March 2009 and believes the ECB would cut rates by 125 basis points by the end 2009.

The market has already moved to price in a 50 basis-point cut in the Federal Reserve’s 2% funds rate at its policy meeting later this month

Central banks in Australia, China and Taiwan have switched to an easing mode to support economic growth as inflation eases and analysts believe other Asian central banks would switch policies.

The Philippine central bank is expected to leave interest rates on hold on Monday after a string of rises since June, signalling a shift of priorities towards supporting growth. – Reuters