Money markets on Tuesday staged a dramatic reversal of Monday’s flight to safety after an influential senator fuelled expectations of interest rate cuts and the Federal Reserve and Treasury moved to increase supplies of government securities.
The price of safe one-month Treasury bills tumbled, with the yield back up 87 basis points to 2.98 per cent by the close of trading in New York. This followed a bizarre government debt auction in which there was barely enough interest to sell the $32bn of securities on offer.
Earlier, Christopher Dodd, the chairman of the Senate banking committee, told reporters after a meeting with Ben Bernanke, the Fed chairman, and Hank Paulson, US Treasury secretary, that Mr Bernanke told him he would use “all the tools” at his disposal to contain market turmoil and prevent it from damaging the economy.
The meeting of the three men on Capitol Hill highlights the increasing political pressure on the Fed and Treasury. Mr Dodd’s comments, coupled with the announcement by the New York Fed that it was cutting in half the fee for borrowing securities from its $785bn portfolio of Treasuries, appeared to turn round sentiment in the money market.
The pull-back from risk-free government securities then gathered pace after dealers offered low bids for the Treasury bill auction. This meant they were auctioned at much higher yields than those available in the market at the time.
The rollercoaster ride in the price and yield of the safest securities is highly unusual. But policymakers see the unusual trading as a sign of the uncertainty as to the extent of portfolio shifts under way in the giant money market sector, which has $2,700bn under management, and not evidence of any new problems in the financial system.
Fed insiders played down the significance of Mr Dodd’s remarks, stressing that there had been no change of policy since Friday, when the Fed said it was prepared to act “as necessary” to protect the economy. Jeffrey Lacker, the hawkish president of the Richmond Fed, said: “The jury is still out on how the market reacted to [the US Fed] policy move.” He said any future decision to cut interest rates should be based on the implications of market turmoil for the economy.
“Financial market volatility, in and of itself, does not require a change in the federal funds rate,” he said.
The turnround in money market conditions followed a desperate scramble for safe government paper in early trading.
“Credit is being repriced, reassessed across our capital markets,” Mr Paulson told CNBC television. “As the Fed addresses liquidity this makes it possible, this makes it easier, for the market to focus on risk and pricing risk. This will play out over time.”
In London, it emerged that Barclays, the UK’s third-biggest bank, borrowed £312m ($618m) under the Bank of England’s emergency facility on Monday, the first to tap the facility since the onset of the liquidity crisis. Barclays is thought to have taken out the loan after another big bank missed a scheduled payment.
HBOS, the UK’s biggest mortgage lender, also stepped in to support one of its specialist financing units with assets worth about $37bn after it was hit by the fallout in the credit markets.
Conditions in equity markets eased a little as the convulsions in the money market moderated. By the close in New York, the S&P 500 index was up 0.11 per cent at 1,447.12. In Europe, leading shares ended the day flat after a late rally.
European shares were weighed down by fresh concerns about the exposure of the German banking sector to turmoil in the US subprime mortgage market.
But shares in Asia continued to rally from last week’s rout. The Morgan Stanley Capital International Asia-Pacific index was up 1.2 per cent by the early evening in Tokyo. This took its rise over the past two days to 5.3 per cent.