NEW YORK, Dec 21 (Reuters) - The supply of dollars in money markets rem
ained tight on Wednesday after the European Central Bank lent nearly half a trillion euros to banks as the euro zone debt crisis rages on.
The surprisingly huge sum of ECB three-year loans should afford 523 banks time to raise capital and rid themselves of bad sovereign investments, analysts and investors said.
'They are finally bringing out the big gun,' said Carl Kaufman, portfolio manager who oversees $2 billion in bonds at Osterweis Capital Management in San Francisco. 'This is a continued stumbling toward the right answer,' he said of the ECB's debut three-year tender.
The ECB is scheduled to hold another three-year ECB loan auction in February.
However, the cost for banks to borrow dollars in the open market remained at distressed levels in the wake of Wednesday's closely watched tender. Other key market barometers signaled the cheap ECB loans to banks did little to revive confidence and encourage investors to lend more dollars, analysts said.
'There is no relief in sight for the dollar funding market,' said Lance Pan, director of investment research at Capital Advisors Group in Newton, Massachusetts. 'Banks do not trust each other.'
The benchmark rate for banks to borrow three-month dollars is approaching its highest level in 2-1/2 years. The London interbank offered rate for three-month dollars rose to 0.57125 percent from 0.56975 percent on Tuesday.
In the interest rate swap market, the spread on the two-year interest swap rate over the two-year Treasury yield , was marginally tighter on the day at 47.25 basis points. The two-year swap spread, which widens with increased anxiety about the global banking system, is only 3 basis points narrower than the 2-1/2 week wide set on Monday.
In other trading, Eurodollar futures for 2014 delivery and beyond fell from 0.05 to 5.5 basis points. This suggest traders expect dollar borrowing costs would rise if banks were to refinance on their three-year ECB loans once they mature.
Some fund managers expect the impact of the ECB three-year tender on dollar borrowing costs to emerge in a couple of weeks when investors deploy their cash once the new year begins.
'It's a net positive. It might have a trickle-down effect over time,' said Bret Barker, portfolio manager at TCW Group in Los Angeles, which manages $114 billion.
With no comprehensive solution to the euro zone crisis in sight, the $2.6 trillion U.S. money market fund industry continued its retrench from Europe, according to a Fitch Ratings report released on Wednesday.
As money funds have reduced their exposure to French and other euro zone bank debt, they have increased their holdings of bank securities outside the 17-nation block. They also beefed up their positions in U.S. Treasury and agency debt.
The 10 biggest prime money funds reduced their overall European exposure by 4 percent in November from October. Since the end of May with the flare-up of the region's debt crisis, they have lowered their European debt holdings by 45 percent, Fitch said.
These funds, with combined assets of $645 billion as of Nov. 30, slashed their French bank exposure by 63 percent last month, bringing the decrease since May to 89 percent, Fitch said.
The decline in French exposure was mitigated by increased holdings in Dutch, Swiss, British and Nordic securities, it said.
Still, the funds' overall European exposure stood at 33.4 percent at the end of November, down from 34.9 percent a month earlier. At the end of May, it was 51.5 percent.
(Reporting by Richard Leong; Editing by Dan Grebler) Keywords: MARKETS MONEY/
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