Short-term interest rates fall again on Fed rate cut, dollar swap lines

Posted Oct 30th 2008 10:33AM by Joseph Lazzaro
Filed under: International Markets, Federal Reserve, Financial Crisis

Short-term interest rates continue their downward trek.

The effort by major central banks to increase the supply of dollars globally to free-up credit continued to move rates in the right direction Thursday -- down -- as private banks were encouraged by the U.S. Federal Reserve's interest rate cut and $120 billion in new swap lines with emerging market central banks.

The London rate for three-month loans in dollars declined for the 14th consecutive day, dropping another 23 basis points to 3.19%. Rates also fell in Asia: the three-month rate for Hong Kong, the HIBOR, dropped 15 basis points to 3.39%.

Meanwhile, the London interbank overnight rate, or LIBOR, plunged another 41 basis points to 0.73% - - its lowest level since January 2001.

Short-term rates, including overnight rates, are key sources of cash for corporations and other large institutions, which use the cash to pay suppliers, make payroll, roll over debt etc. Hence, very high overnight and short-term rates will discourage corporations from conducting business, restricting commerce and slowing the economy, economists say.

Fed rate cut, swap lines help

Economist Peter Dawson said the Fed's interest rate cut to 1.00% from 1.50% and decision to provide $30 billion in swap lines to Mexico, Brazil, South Korea, and Singapore added to momentum in credit markets to free-up dollars.

"The Fed swap lines really helped and it's getting private bankers' attention, as evidenced by the below 1% interest rate for overnight LIBOR. The rate is now below what it was in January 2001 and if it stays there that would be very good news," Dawson said.

"The central bank swaps will also take a lot fear out of the market by telegraphing to private banks that it's irrational to hoard dollars when a profitable, appropriate bank-to-bank loan could be made," Dawson added. "Banks don't make money by having deployable capital sit idle. Eventually the pressure will build to push this money out there and make some dough, which is the essence of credit market liquidity."

The LIBOR is particularly important because it determines rates on $360 trillion of financial products worldwide, from home loans to derivatives.

U.S. and European governments have now pledged as much as $3.4 trillion to unfreeze credit markets, meet demand for dollars, and recapitalize banks.

Monetary Policy / Economic Analysis: As economist Dawson noted, pressure -- the good kind of pressure -- is building on private banks to push money into the market, which points to increased financial system liquidity.

Tags: banking sector, BankingSector, banks, bond market, BondMarket, Brazil, credit markets, CreditMarkets, emerging markets, Fed, interest rates, inthenews, LIBOR, Mexico, monetary policy, Singapore, South Korea, swap lines