Wednesday, June 25, 2008

US benchmark confirms dollar Libor

(FT) A US benchmark launched two weeks ago to measure funding pressures in the American dollar markets has produced results similar to the pattern in the dollar Libor index calculated in London, bankers have said.

The borrowing rate reported in the new index, which is run by Icap and known as the New York Funding Rate, is now tracking the official Libor rate set by the British Bankers Association.

This development might remove some heat from allegations that the London dollar Libor index is a misleading guide because it is set outside the US markets.

If so, this is likely to be welcomed by US policymakers and bankers, many of whom had feared that Libor's loss of credibility was undermining investor confidence in the money markets more widely.

The BBA, which sets dollar Libor based on the average borrowing costs of 16 banks, fixes the rate in London before the US market opens and only uses three US-based banks. The BBA fixes Libor rates for 10 currencies, including the euro, sterling and the dollar.

The NYFR polls at least 16 New York banks after the US market opens. Some western policymakers and bankers believe that polling banks after the market opens is more appropriate, given the scale of US contracts now linked to Libor.

Since NYFR started life on June 11 it has fixed at similar levels to dollar Libor.
Icap's three-month NYFR, for example, yesterday was fixed at 2.7992 per cent compared with a three-month dollar Libor rate of 2.8043 per cent.

One-month NYFR set at 2.4962 per cent compared with a one-month dollar Libor rate of 2.4825 per cent.
Some bankers think the levels of one-month and three-month Libor compared with overnight rates set by the US, UK and European banks since the credit squeeze reflect tougher financial conditions.

Laurence Mutkin, head of European interest rates strategy at Morgan Stanley, said: "Bank funding costs or Libor rates are higher because the way banks are now rationing their balance sheets means they are putting up the price of borrowing. You can see that in the wider economy with higher lending rates. In that situation, it would be surprising if Libor didn't go up."

Willem Sels, head of credit strategy at Dresdner Kleinwort, said: "On the interbank rate issue, you need to bring back confidence to the market that these rates are reflecting funding costs, so having another fixing in New York, which is using US-based banks, may help to do that."

The rising controversy about the dollar Libor index has been closely watched by central bankers, not least because some officials fear that the debate could be contributing to a broader sense of investor unease in the money markets.

The problem has been exacerbated because it has become clear that a far larger proportion of the market in the US is tied to the Libor index than many observers had previously realised.

Libor is used by about $350,000bn of financial products, the most widely used interest rate benchmark.

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