Market Insider

Central Banks Bringing Risky Back

Currency swap spreads are contracting, volatility is falling and stocks are soaring following a coordinated move by central banks to make dollars cheaper.

Tom Grill | Photographer's Choice | Getty Images

But, market watchers say that Wednesday's coordinated action by central banks shows that officials are getting more concerned about the financial crisis in Europe with its potential contagion effects and constant funding pressures, and are perhaps less excited about the improving jobs picture in the United States.

There is no doubt that the purpose of today’s coordinated action by the central banks of the United States of America, Canada, England, Japan, Europe and Switzerland was to ease the financial strains in the global banking system. The precipitating reason for today’s action is unclear, but it is also clear that short term funding rates were spiraling out of control.

Just before the news hit the wires this morning, Lawrence McDonald, author of, “The Inside Story of the Collapse of Lehman Brothers” posted this on Twitter:

"Euribor OIS 3 Month Spread now 48% out to the Oct 2008 Lehman wides, bad for lending, the consumer and economic growth."

Following the announcement of the coordinated action, Euribor 3 month spreads contracted as well as what McDonald calls a "massive" decline in the 2-year dollar swap spread.

But, while the immediate trading reaction sent rates in the right direction, most do not see this as a resolution of the underlying problems.

“Stocks have responded more enthusiastically than the money markets in part because money markets know that European private commercial banks need to raise about 800 billion euros or 1 trillion dollars next year," says Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman.

Spreads have narrowed a bit, making it cheaper and easier to swap dollars into euros he says but, there are still warning signs. “Germany has a 1-year note that is at negative interest rates for the first time."

Looking ahead, traders are talking about the need for a cut in the discount rate by the Federal Reservearguing that that cheaper dollar funding for foreign banks should be met with cheaper funding for U.S. banks. The discount rate, the rate at which banks can borrow short-term funds from the Federal Reserve, is currently pegged at 0.75 percent.

But, Dan Greenhaus, BTIG Chief Global Strategist is more interested in whether or not the European Central Bankcuts interest rates when its Governing Council meets on December 8th.

"Central banks are supplying support, ECB will be next, plus the better economic data, and you have the seeds for a rally," he says.


Follow Lori Spechler on Twitter: @lorispechler