The rise in the cost of borrowing dollars, which had been unchanged the day after Tuesday’s auction, was small at just one-quarter of a basis point, or 0.0025 per cent, but it is a concern for money markets because it is a move in the wrong direction.
European banks have widespread holdings of US dollar assets mainly in the form of mortgage-backed bonds and related structured credit, but they have found it increasingly difficult to renew their US dollar funding in the wake of the credit crisis.
Liquidity in euros and even sterling also remains tight, but dollar funding is by far the hardest to come by and this is why the relatively small central bank liquidity auctions are having limited impact.
“These liquidity auctions have not been effective at all,” says Alessandro Trentori at BNP Paribas. “The spread between overnight rates and Libor rates has continued to widen. This is a sign that the financial system is still stressed and it needs additional measures.”
Tuesday’s auctions saw European banks bid for almost four times the $10bn on offer from the European Central Bank, while the US end of the auction saw demand for more than twice the $25bn on offer from the Federal Reserve.
The auction settled the cost of the three-month funding at just 5bp lower than the day’s three-month dollar Libor rate of 2.80438 per cent. On Thursday, three-month dollar Libor ticked up to 2.80688 per cent.
Markets reacted well when the three-month auction was announced in late July but that was extremely short-lived, which one European bank liquidity manager put down to the very small aggregate increase in funding through the reshuffling of maturities.
The manager said the timing of the change came at a period of relative steadiness in Libor rates, which could signal that central banks wanted to test the sensitivity of the market to different measures.
“Because of that I wonder if it will be the start of a series of changes – it will be interesting to see if they up the amounts available next month,” the manager said.
Others put a more positive light on the auctions.
George Goncalves, at Morgan Stanley, said: “Demand stays strong for Fed-based liquidity, but the positive is that having these facilities in place means that funding volatility should dampen.”