MONEY MARKETS-Dollar funding rates ease, seen close to bottom

* Dollar funding rates fall to lowest since early April

* Dec. eurodollar contracts show big rise in LIBOR

* South Korean IRS curve flattens ahead of cbank vote

By Umesh Desai

HONG KONG, Sept 8 (BestGrowthStock) – Dollar funding rates fell on
Wednesday after holding steady for two straight days as renewed
concerns about the health of the European banking system
triggered a wave of risk aversion.

Money markets have already factored in a second round of
quantitative easing by the U.S. Federal Reserve, traders say, a
prospect which is seen preventing rates from rising sharply
from current 5-month lows, although eurodollar contracts show a
big rise by year-end.

The average cost of 3-month funds in Singapore
(SIUSD3MD=ABSG: ) fell to 0.29956 percent from 0.30056 percent
after easing nearly 18 bps last month. The benchmark last rose
on July 16.

“There was a bit of panic because of the Journal article
which has been spooking the market since London trading
yesterday,” said a Singapore based money markets trader.

Worries about Europe’s banks surfaced anew on Tuesday when
the Wall Street Journal reported that some major lenders had
understated holdings in potentially risky government debt
during “stress tests” designed to test their ability to weather
crises.

Ireland’s extension of guarantees for short-term banking
liabilities added to jitters about the European banking
sector.[ID:nLDE6861YN]

But further declines are unlikely, the Singapore-based
trader said as a second round of quantitative easing is already
anticipated by the money markets.

“The only way rates can go down further is if the Fed cuts
interest rates on reserves. If not it means the effective Fed
funds rate is going to be 19 or 20 bps and 10 bps is the bare
minimum FRA OIS spread for interbank risk,” he said.

The FRA/OIS (forward rate agreement/overnight index swaps)
spread for one month (USDF-OIMM1=R: ) is around 10 bps, down from
the 12-month high of over 50 bps in June. It is a stress
indicator.

But an aggressive round of quantitative easing is unlikely
given worries it may generate inflation and on the view that
the economic recovery is strengthening, albeit gradually and
unevenly.

“While new QE is likely in the U.S. and possible in the UK
and Japan if growth slows further, it may be ‘too little too
late’, keeping the upswing weak,” said a report from Standard
Chartered Bank.

“The implications are positive for bond markets but suggest
continued volatility for risk assets. Official rates could stay
low for a very long time.”

Overnight, three-month dollar Libor (USD3MFSR=: ), an
indicator that drives Asian dollar lending rates, was fixed at
0.29188 percent, the lowest since early April and down from
0.29219 percent late on Monday.

But eurodollar futures are still pricing in a 3-month LIBOR
at 45 basis points (EDZ0: ) by December.

“We are pricing LIBOR unchanged for today, although markets
are expecting high rates based on December contracts,” the
trader in Singapore said.

In South Korea, the IRS curve flattened as the market
priced out some of the excess hawkishness on the eve of the
central bank rate decision on Thursday.

The 4- and 5-year won IRS (KRWIRS: ) fell by 4-5 basis points
with the front end declining to a lesser degree, flattening the
IRS curve.

A Reuters poll shows the Bank of Korea is expected to
raise the base rate by 25 basis points to 2.5 percent on
Thursday, leaving the door open for at least one more increase
later this year. [ID:nTOE68202H]

“There is scope for front end rates to rise particularly if
the BoK’s rhetoric is on the hawkish side. We stay paid on the
1 year IRS heading into the policy meeting,” said a client note
from Royal Bank of Scotland.
(Editing by Kim Coghill)

MONEY MARKETS-Dollar funding rates ease, seen close to bottom