Money markets repo premiums pull back; european lending rates fall

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* Premiums fade on 5-, 7-years in U.S. repo market * Fitch sees uptick in money funds' exposure to euro zone banks * Interbank funding rates fall ahead of ECB 3-month tender By Emily Flitter NEW YORK, Feb 23 The high premiums on five- and seven-year Treasury notes as repurchase collateral eased on Thursday on short-covering following Wednesday's rebound in Treasury prices. Repo traders were paying dearly to borrow five- and seven-year notes in exchange for cash in overnight transactions, and the reason for the high premiums at first had appeared elusive. But the easing of conditions on Thursday after the rebound in Treasury prices suggested traders had been borrowing the notes in the repo market to back up bets that Treasury prices would fall. By Thursday, those who had only wanted to borrow the securities were now being forced to buy them outright, reducing overall demand in the repo market. According to Roseanne Briggen, an analyst at IFR Markets, a unit of ThomsonReuters, seven-year notes were trading at -10 basis points to -20 basis points as repo collateral, back from their previous rate of around -200 basis points. Meanwhile, funding pressures in Europe appeared to be easing on Thursday, as interbank lending rates in euros and dollars fell ahead of the European Central Bank's next liquidity tender. The drop in interbank lending rates reflected expectations the European Central Bank's next dose of three-year funding will send another wave of ultra-cheap liquidity into the market. A report from Fitch Ratings on U.S. prime money market funds' exposure to European banks also suggested some relief for banks in Europe. Fitch found money funds increased their exposures to euro zone banks by 15 percent on the dollar in December following months of steady pullback from Europe. Fitch said the change could represent "a new equilibrium" for money funds, which make short-term loans to European banks by buying their commercial paper issues. The change is coming as euro zone banks grow less reliant on U.S. money funds. "Even if money market fund risk aversion were to soften, euro zone banks might have diminished appetite for MMF funding going forward," Fitch said in the report, since European regulators are urging banks to reduce their reliance on short-term dollar funding. The total amount of foreign commercial paper outstanding in the U.S. market decreased during the week ending Feb. 22 compared with the previous week, according to data released on Thursday by the Federal Reserve. Key three-month interbank lending rates are at the lowest level in over a year and are closing in on the ECB's benchmark interest rate of 1 percent in anticipation that next Wednesday's second offer of ECB funds will pour another half a trillion euros into the banking system. Three-month Euribor rates, traditionally the main gauge of unsecured euro lending between banks and a mix of interest rate expectations and banks' appetite for lending, fell further on Thursday to 1.014 percent from 1.021 percent, hitting their lowest level since January last year. Analysts said unless the demand for ECB loans was well in excess of current expectations, there was limited scope for a fall far below the 1 percent level with much of the liquidity injection's impact already showing in forward prices. Reuters polls of economists and traders showed demand was forecast to be just under half a trillion euros. Euribor futures showed markets were anticipating rates to fall to 0.92 percent by next month, with an additional drop to 0.82 percent by the end of the year. The LIBOR rate, fixed by a smaller panel of banks in London, was also trending lower. The benchmark three-month rate fell to 0.93421 percent. Forward rate agreements showed Libor was expected to bottom out at around 0.80 percent in the second half of the year. Overnight deposits at the ECB hit a record high of 528 billion euros at the beginning of the year and topped the half a trillion mark again last week at the peak of the ECB monthly reserves cycle.