Finance Weblog: How much money is needed to reduce money market risk premia?

This is the question Central Banks ask themselves. They first asked themselves individually and later on (last Wednesday) they though they might get together to make this reflection together. We might be able to get some conclusions on this question if we follow the most recent events and market data.

We have received little news from the most innovative tool that has recently been released y the Fed to provide liquidity, the TAF (Term Auction Facility). This latter tool is a hybrid between traditional open market operations (limited to a small club, main dealers) and the discount window (open to any depositary institution but at a penalty rate). The first TAF was implemented yesterday but we know little about the results. I searched in the NY Fed webpage and found no information. However, we might get some indirect information from today’s dollar LIBOR fixing. I looked into the dollar LIBOR fixing and it showed that it was hardly affected. The LIBOR for the corresponding maturity has barely moved. So for the Fed, we can just say that they missed the target.

Let us look now into the ECB. The ECB has been pretty generous on liquidity provision. May be too generous. On this ground the ECB has been critized and many commentators claim that these continuous liquidity injections might have keep alive a very ill bank. We do not know about this, so far. But it is true that we have seen less write downs from European banks that US banks. The ECB made a huge movement yesterday (17th of December 2007) in the market providing almost €170bn extra liquidity at below market interest rates. As of late Monday afternoon the ECB was planning to provide €180.5bn on a two week basis below current interest rates, but it ended up providing €348.6bn. The ECB opened the pump and money flew like water. Wish I were a depositary institution!

The end effect of this is that in today’s’ fixing the Euro two weeks LIBOR rate fell 50 basis point in relation to yesterdays mark(see figure). This is a true correction in the two weeks segment. The end story is that Central Banks need to provide more liquidity that expected to press down money market rates. Whether this is wise or not is a different issue.

BBA EURO LIBOR.jpg

Trackback Pings

Comments

Post a comment