Tuesday, August 21, 2007

Fed fails to calm money markets

Fed fails to calm money markets
By Krishna Guha in Washington and Francesco Guerrera and Saskia Scholtes in New York
Copyright The Financial Times Limited 2007
Published: August 20 2007 14:52 | Last updated: August 21 2007 00:32

Money market investors staged a dramatic flight to safety on Monday, knocking down yields on short-term US government debt, as top Treasury and Federal Reserve officials continued behind-the-scenes efforts to maintain confidence in the credit markets.

The yield on the one-month Treasury bill fell 160 basis points to 1.34 per cent in early trading, while the yield on three-month Treasury bills tumbled to 2.51 per cent at one point, 123 basis points below Friday's close - a sharper fall than during the October 1987 stock market crash.

The one-month Treasury bill later recovered to close down 62 basis points on the day at 2.33 per cent, while the three-month bill finished 3.09 per cent down, a fall of 66 basis points on the day.

The scramble to obtain government paper, at almost any price, is a sign of extreme risk aversion and suggests that the Federal Reserve's actions on Friday have yet to stabilise the credit markets. This, in turn, is encouraging speculation that the Fed will have to cut interest rates soon.

“We had clients asking to be pulled out of money market funds and wanting to get into Treasuries,” said Henley Smith, fixed-income manager at Castleton Partners. “People are buying T-bills because you know exactly what’s in it.”

Separately, it emerged that Deutsche Bank had taken advantage of new loan terms offered by the Fed to banks on Friday to ease the current credit squeeze.

There was also unease in Europe, where companies continued to face problems raising funds in the asset-backed commercial paper market - a key source of funding for financial companies. Data from Dealogic showed companies failed to refinance more than 80 per cent of ABCP paper that matured on Monday.

This has created financing problems at two German banks and if the trend goes on it could hurt other financial institutions.

Top Treasury and Federal Reserve officials on Monday continued their efforts to restore confidence in the markets. Hank Paulson, US Treasury secretary, and senior Fed officials have called large institutional investors and banks in an attempt to restore confidence.

One large institutional investor said he had been called by a senior Fed official seeking to “explain” Friday's decision to lower the discount rate and argue that market conditions were improving.

Policymakers on Monday denied having specifically asked investors to buy into the market, but acknowledged they had encouraged them to consider the “signals” their actions sent.

Deutsche Bank's decision to borrow from the “discount window” came on Friday, just hours after the Fed decided to lower the rate on these loans.

Additional reporting by Gillian Tett


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