A Step into the Market, Central Banks Add Liquidity

The world's major central banks have made the decision to step into the market and help the financial markets ease some of the money market tensions.

Inter-banking liquidity had completely drained out in the last few days, as more and more financial companies come very close to bankruptcy. As such, the thee-month LIBOR rate, the rate at which banks lend funds to each other, had the biggest gain since 1999, advancing over 19% to 3.06%. Three month treasuries fell yesterday to the lowest level ever recorded, as investors look for safety.

Inter-banking liquidity can also be measured by the so-called Ted Spread (difference between the three-month Treasury bill and three month LIBOR rate), which widened by 0.84% to 302 basis points, almost a record. Readers should be aware that in normal market conditions, the Ted spread averages significantly under 1%. Not anymore, it seems.

Another way for a financial institution to access liquidity is by opening market operations from the “local” central bank. The latest open market operations held yesterday by the ECB shows just how starved banks are for liquidity. The ECB received a record €328b in bids for €150b. This clearly shows financial institutions are in great need for liquidity. Today, the ECB has received $101b worth of offers for the $40b auctioned in the TAF deal.

The Fed has authorized foreign central banks to use as much as $247 billion (although initially reported at $180 billion) in open market operations to shore up the balance sheets of financial institutions (or what is left from them). The ECB can use as much as $110 billion, from which it has already used $65 billion in two overnight repos. The Swiss national bank used $10 billion out of the $27 billion available in an overnight operation. Bank of Japan used all of the available $60 billion to add dollar liquidity to the Japanese based banks; the decision was taken in an emergency meeting. Also, the Bank of England and the Bank of Canada are now allowed to carry out dollar open market operations worth $40 billion and $10 billion, respectively.

The last time the central banks cooperated to add dollar liquidity to the market was back in December. The outcome in the currency market was initially a stronger dollar, but soon gave up those gains. Right now, the charts look like the market is trying to sell the dollar, as the prospects of another rate cut are increasing. This would be a hard hit to the dollar's valuation; if we remember that just a few weeks ago the dollar was getting stronger because the market viewed the next Fed move would be a hike. Furthermore, analysts pooled by WSJ said this is more of a temporarily fix, since it still will not help bank's avoid any more write-downs.

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