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US Money Market Funds Return to Euro Zone

US money market funds have increased their exposure to eurozone banks, in the latest sign of returning confidence in the stability of Europe's monetary union.

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Exposure to eurozone banks of US prime money market funds at the end of September was 16 percent higher on a dollar basis than a month earlier, according to Fitch Ratings. The third consecutive monthly rise followed a pledge in late July by Mario Draghi, European Central Bank president, to do "whatever it takes" to preserve the euro's integrity.

The US money market funds are an important source of dollar funding for European banks. Last year, as the eurozone debt crisis escalated and fears grew of Greece exiting the bloc, the funds reduced sharply their lending to the eurozone, exacerbating banks' funding problems. Although there was a pick-up early this year, US money market funds' exposure fell further over the summer.

(Read More: Draghi Alone Cannot Save the Euro)

Mr. Draghi's comments, and plans drawn up by the ECB for possible intervention in eurozone government bond markets, have helped stabilize the banking sector in crisis-hit "periphery" countries such as Spain. Last week, the ECB reported Spanish bank deposits had increased for the first time in six months. Spanish and Italian banks have also reduced their reliance on loans from the ECB.

But US money market funds exposure to the eurozone remains low – and they continue to avoid banks in the periphery.

Even after the latest rise, exposure to eurozone banks accounted for less than 11 percent of the money market funds' holdings – compared with a peak of more than 30 percent in May 2011. The fall reflects changes in eurozone banks funding models and reduced reliance on dollar funding – as well as US sentiment towards the eurozone, according to Fitch.

"I would describe September's rise as a slight increase rather than a reversion to 2011 levels," said Robert Grossman, Fitch credit research analyst. But he said US money market funds acted as early indicators of investor trends. "These are very conservative, short-term investors. They typically reduce exposures very quickly when there are credit issues – which is why they are good indicators," he said.

The Fitch survey of the 10 largest US prime money market funds, representing about $650 billion in assets under management, showed a particularly strong increase in their exposure to French banks in September. It also showed the funds scaling back their reliance on US government debt markets while exposure to Japanese banks, which has increased steadily over the past year, remained stable.

Fitch also found that the US funds' exposure to European banks had shifted away from secured lending to unsecured lending – another sign of an improvement in sentiment. In September, just 30 percent of the funds' exposure to European banks was accounted for by "repo" transactions, by which banks pledge securities as collateral for short-term loans from money managers. That was down from 37 percent in August and the lowest since March.

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