LDN - Business

Where's the floor? Investors left guessing as U.S., Europe money market rates sink

[October 21, 2020] By Dhara Ranasinghe

LONDON (Reuters) - A widely-used benchmark for U.S. short-term interest rates has dropped to record lows, joining its European peers, in the latest sign that massive central bank stimulus has suppressed borrowing costs.

The three-month U.S. dollar London Interbank Offered Rate (Libor) hit a record low at around 0.21% <USD3MFSR=> on Tuesday and held near those levels in London trade on Wednesday. It is down more than 100 basis points from highs hit in March at the peak of market volatility triggered by the coronavirus crisis.

Libor is a global interest rate that forms the price reference embedded in derivatives contracts and loans worth $400 trillion globally.

"There is a disconnect between the peak we saw in Libor in March and the record lows we are seeing now," said ING senior rates strategist Antoine Bouvet.

"What is confounding us is that credit risk is being underpriced."

For a graphic on USD LIBOR:

https://fingfx.thomsonreuters.com/
gfx/mkt/oakpenegdvr/USD%20LIBOR.JPG

Interbank lending rates should reflect some credit risk but that has been suppressed by the weight of central bank stimulus, analysts said, a development that also been reflected in tighter corporate bond spreads this year.

The transition in Libor rates to a new interest rate benchmark - Secured Overnight Financing Rate (SOFR) - may help explain the move down as one rate converges with another.

And the move speaks to the bigger fall across money market rates in major economies, triggered by the pumping of cash into markets by central banks to offset the impact of the coronavirus shock, analysts said.

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Rolled Euro banknotes and 3D-printed percent models are placed on U.S. dollar banknotes in this illustration taken May 26, 2020. REUTERS/Dado Ruvic/Illustration/

Others noted that expectations for fiscal stimulus may also be in play.

"What you are seeing now in the U.S. and euro money markets is that we are in an environment of extremely low market liquidity which is pushing rates low, there is no risk that we saw earlier this year," said Jan von Gerich, chief analyst at Nordea.

Total Fed balance sheet assets have increased just over $7 trillion as bond purchases for quantitative easing approach $3.1 trillion, according to TD Securities.

In Europe, a key money market rate -- three-month Euribor -- has also fallen to record lows in recent weeks amid the abundant liquidity the European Central Bank has unleashed across the bloc's financial system.

On Wednesday, this rate was fixed at -0.507% <EURIBOR3MD=>, within sight of a record low hit last week at -0.51%.

"We are all left guessing what the floor in Libor and Euribor will be," said ING's Bouvet.

For a graphic on EURIBOR:

https://fingfx.thomsonreuters.com/
gfx/mkt/bdwpkjkrzvm/EURIBOR.JPG

(Reporting by Dhara Ranasinghe; Graphics by Saikat Chatterjee; Editing by Karin Strohecker and Jane Merriman)

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