By Kevin Plumberg
HONG KONG (Reuters) - Money markets still reflected a crisis of confidence, despite passage of a $700 billion bailout in the U.S. Senate on Thursday, suggesting central banks will have to keep the financial system on life support.
Billions of dollars of liquidity injections by central banks around the world, emergency currency swap programs and the most comprehensive effort yet by Washington to stem panic in financial markets have had limited success in freeing up the flow of credit among commercial banks, especially in longer-dated lending.
The European Central Bank is widely expected to keep its benchmark interest rate on hold at 4.25 percent after a policy meeting later on Thursday, but expectations were growing for the ECB to signal it stands ready to cut borrowing costs to support its economy.
Meanwhile, most interbank borrowing rates have continued to rise relative to expected central bank benchmark rates, reflecting a firmly entrenched aversion to counterparty risk.
"We view the continued widening of the spreads as an indication of the belief in the money market that the bailout plan will not solve the root causes of credit crisis," said Dariusz Kowalczyk, chief investment strategist with CFC Seymour in Hong Kong.
Kowalczyk said in a note that declines in house prices and confidence in the financial system have to be addressed before lending markets can funtion properly.
The complete absence of confidence within the bank industry has kept money markets tight, especially after September when Lehman Brothers went bankrupt, the U.S. government rescued American International Group and surviving Wall Street banks had to completely restructure themselves.
As a result, central banks have put on a balancing act between pumping billions of dollars of liquidity into the financial system and then draining the excess funds.
The Bank of Japan has stepped up its efforts to meet the liquidity demands of an array of banks. It injected 1 trillion yen of one-week funds, and then added another 600 billion yen of overnight cash. Japanese lenders have been asking for 0.7 percent or more for overnight cash, above the BoJ's 0.5 percent target rate, sending foreign banks to the central banks' door.
GLOBAL RECESSION LOOMS IN THE BACKGROUND
Elsewhere in Asia lending markets appear dysfunctional.
The Reserve Bank of Australia effectively drained A$376 million from its banking system, though cash balances were kept near record highs around A$9 billion and interbank rates remained elevated.
Meanwhile, 3-month interbank lending rates in Hong Kong rose despite measures by the Hong Kong Monetary Authority this week to lengthen the duration of its operations and accept a wider array of collateral in return for cash.
Three-month Hong Kong interbank offered rates were fixed at 3.7943 percent, not far from a 2008 high of 3.7966 percent reached last week.
In Singapore, the 3-month interbank rate was fixed at 4.1567 percent, the highest since mid January.
The U.S. Senate easily passed a bill that gives the federal government power to buy up to $700 billion worth of illiquid securities from private financial institutions. The bill will now appear before the House of Representatives on Friday for a second time after a stunning defeat earlier this week shook markets.
Still, skeptics wonder how exactly the bill, which did include tax cuts in the Senate version, will stimulate economic growth.
Signs of U.S. economic weakness have spurred interest rate futures into reflecting a 2-in-5 chance of a half-percentage point cut in the Federal Reserve's target rate when it meets at the end of the month. A 50 basis points cut has already been priced in ahead of a Reserve Bank of Australia meeting next week.
"There will be a bailout package in one form or another. That will bring more stability to markets. However, the package itself
is mainly facilitating a wealth transfer from shareholders of failed financial institutions to shareholders of the surviving giants," said Erwin Sanft, head of China & Hong Kong research with BNP Paribas in Hong Kong.
"In terms of what's happening in the real economy, it looks
impossible at this point to avoid a global recession next year."
Progress on Washington's most comprehensive effort yet to stem a threat to the financial system pushed traded overnight U.S. dollar borrowing rates down to 3 to 5 percent, down from highs of 6 percent on Wednesday.
Focus will likely shift to the latest fixing in London interbank borrowing rates relative to expected central bank target rates and U.S. Treasuries in wake of the Senate's approval of the bailout plan.
On Wednesday, the spread of 3-month U.S. dollar Libor over the overnight index swap narrowed a touch to 245.25 basis points.
The spread of 3-month dollar Libor over the same maturity U.S. Treasury bill yield was 336 basis points, down slightly from Monday's 374 basis points, the widest since beyond 1986, according to Reuters EcoWin.
(Additional reporting by Chikako Mogi in Tokyo and Kevin Yao in Singapore)
