MONEY MARKETS-Traders raise bets on more Fed stimulus

by on July 25, 2012 5:56 pm BST

Wed Jul 25, 2012 1:56pm EDT

By Richard Leong

(Reuters) – U.S. interest rate futures
climbed on Wednesday, as traders increased their bullish bets
that the Federal Reserve is prepared to provide more stimulus to
counter a slowdown in the U.S. economy, exacerbated by Europe’s
debt crisis.

Deferred Eurodollar futures rose for a fourth straight
session, touching fresh contract highs.

The recent slew of discouraging news on the U.S. economy,
together with worrisome developments in the fiscal situation in
Spain and Greece, fed expectations the U.S. central bank could
soon act with more unconventional policy tools to lower interest
rates in a bid to stimulate borrowing and business activities.

Fed’s remaining policy tools include a third round of
quantitative easing in the form of large-scale bond purchases —
known as QE3 — and lowering the interests it pays banks on
excess reserves (IOER) they leave with the central bank.

“The market is looking for the Fed to ease at some point
with a cut in the IOER and/or a full-blown QE,” said Mike Lin,
director of U.S. funding at TD Securities in New York. “That’s
supporting the move of Eurodollar futures higher.”

The December 2014 Eurodollar contract last traded up
1.0 basis point at 99.390 after rising to a contract high at
99.395. Eurodollar futures for 2016 to 2019 edged lower after
setting contract highs earlier.

Interest rates in the dollar funding market had fallen since
last week in anticipation the Fed would lower the IOER from the
current 0.25 percent.

Traders bet the Fed would follow the European Central Bank
which almost two weeks ago dropped its rate similar to the IOER
to zero in an effort to bolster the region’s sagging economy.

However, many analysts said the money markets in Europe and
the United States are different. They said cutting the IOER
would hurt the $2.5 trillion money market fund industry and risk
disrupting interbank dollar lending.

Still sentiment on a IOER cut was reinforced by news reports
on possibly more Fed action.

“All the stories are indicating a potential chance about an
IOER cut next week,” TD’s Lin said.

Fed policy-makers are scheduled to meet for two days
starting next Tuesday.

While the futures market signaled expectations of lower
U.S. interest rates, overnight borrowing costs for dollars were
steady to slightly higher on the day.

The interest rate on overnight repurchase agreements, a key
funding source for Wall Street, traded mostly at 0.22 percent,
compared with 0.208 percent — Tuesday’s level on the DTCC GCF
repo index level — which is the benchmark for repo futures
launched more than a week ago.

Analysts said the overnight repo rate rose partly on Fannie
Mae and Freddie Mac either reinvesting or disbursing to
bondholders the monthly cash the two mortgage finance agencies
collect from the home loans and securities in their portfolios.

Benchmark three-month dollar Libor held at
0.44810 percent, its lowest level since early November.

The gap between the London interbank offered rate and the
overnight indexed swap rate for three-month dollars
shrank 1 basis point to 30 basis points.

In the derivatives market, the spread between the two-year
U.S. interest swap rate and two-year Treasuries
narrowed 0.5 basis point to 22.25 basis points, suggesting
traders see chances of more Fed stimulus would help the banking