Overnight Dollar Libor is three times FED’s target

September 16, 2008

From Reuters:

“The U.S. Federal Reserve added $50 billion in temporary reserves to the banking system on Tuesday, according to the New York Federal Reserve web site.

Earlier on Tuesday, the Fed said it would arrange a big overnight repurchase agreement and was ready to arrange further operations later in the day as needed.

As the fallout from Lehman Brothers’ collapse at the weekend continued to infect financial markets, the interest rate banks demanded for lending dollars overnight to other institutions ballooned to more than five times the U.S. Federal Reserve’s 2 percent target rate.

London interbank offered rates (Libor) for overnight dollars as fixed by the British Bankers Association — which trillions of dollars of derivative, financial and corporate contracts are referenced against — soared to 6.43750 percent

‘In addition, at around 9:30 a.m. (EDT) the Desk will conduct its typical Tuesday morning $20 billion, 28-day single-tranche repo, settling 1-day forward,’ the New York Fed said in a statement on its Web site.

After the operation, federal funds traded in the U.S. interbank market slipped to 2.0 percent, matching the target rate the Federal Reserve sets, from 3.0 percent earlier on Tuesday. ”

Commentary: The bid-ask spread on overnight dollar has widened to extreme levels, drying out interbank liquidity. The Fed is injecting large amounts of short-term liquidity in order to prevent a cascade of bankruptcies at international institutions. It appears that the Fed will be forced to bailout AIG at some point. The psychological intensity of the situation is probably more than they can bear.  

At about the same time, ECB offered 70 billion euros ($100 billion) in a one-day refinancing operation, with 56 banks bidding for a total of 102.5 billion euros. The Bank of England injected 20 billion pounds ($36 billion).

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