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Net Net: Promoting innovation and managing change

Rumors of Bank Intervention Stir Euro Markets

surprised many on Thursday by rallying despite bad economic news and gloom over Greece.

European Central Bank
Getty Images

One explanation for the rally is a widely circulating rumor across trading desks speculating about the possibility of joint intervention by central banks to provide liquidity to financial institutions across the globe.

When the Federal Reserve and five other central banks announced easier terms for swap lines in late 2011, the Dow Jones Industrial Average rose 490 points. (Click here for an explanation of how the swap lines work.)

European banks have been paying high rates to borrow in U.S. dollars, especially for loans with terms that stretch out past the European Central Bank's three-year Long Term Refinancing Operation.

"There's a real desperation for term dollar funding right now," one currency trader based in London said.

This may be just wishful thinking among market participants. There has been no indication from any central bankers that they are considering a policy change.

"It's speculation based on stress in the dollar funding market," the trader said. "Liquidity is drying up, so people think the Fed and ECB will cut a deal." 

The ECB had no comment.

Two other traders interviewed by CNBC said they hadn't heard any chatter about an intervention, though one trader said the front ends of the G7 interest curves are certainly trading like there IS going to be policy action.

The last time the central banks announced a joint liquidity operation, the cost of borrowing from the Fed under the swap lines was cut in half from 100 basis points. That leaves little room for further cuts. A cut to 25 basis points would mean that the Fed was right up against the zero boundary, where further cuts would be all but impossible.

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