MONEY MARKETS-Dollar spreads tighten while awaiting Fed

A further fall in dollar bank-to-bank lending rates and anticipation of another U.S. rate cut depressed dollar spreads further in Asia on Tuesday, although markets were expecting no big surprises from the Federal Reserve.

In Japan, where rates are already at an ultra-low 0.3 percent and the economy possibly poised for its longest ever slump, the central bank governor said monetary conditions were becoming less accommodative..

The Bank of Japan meets to review rates at the end of this week

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Meanwhile, South Korea's central bank pumped another $50 million into its swap market and a rising cross-currency swap pointed to improved access for local banks to dollar funding.

In U.S. dollar funding markets on Tuesday, three-month dollar rates in Singapore dropped to 1.86 percent from 1.9 on Monday, slipping further down from highs of 2.24 percent at the start of December.

"They (the Federal Reserve) will cut the target rate, by 50 basis points," said Peter Jolly, head of research at NAB Capital in Sydney.

"But I can't see what else they can pull out of their hat to surprise us, to be honest," he said.
The effective overnight dollar cost in U.S. markets is already near zero, far below the target one percent rate. The Fed is expected to announce its policy statement at 1915 GMT.

Analysts at Bank Julius Baer said the Fed would focus its unconventional policy measures more on bypassing the banking system than on removing duration risk.

Other analysts had a range of expectations from the Fed statement, such as a more explicit commitment to buy longer term Treasuries and agency debt -- a proposal that Fed Chairman Ben Bernanke had outlined earlier which pushed Treasury yields across the curve sharply lower.

U.S. overnight index swaps, which had until last week fallen steadily on expectations of the Fed funds rate being halved, were higher, with the 3-month dollar OIS at 0.29 percent, off a trough of 0.2 earlier in December.

The spread between three-month dollar Libor and overnight index swaps eased overnight to 157 basis points, a sharp narrowing from 191 last week.

The two-year swap spread, the spread between swaps and comparable Treasury yields, declined to 103.75 points from levels as high as 123 earlier this month.

"Libor is responsible for all the 32 basis points narrowing in the TED spread in the last week but we think it's a matter of time before greed outweighs fear and the T-bill rate starts to contribute," ING said in a note to clients.

KOREAN SPREAD
In Korea, the one-year cross currency swap showed the dollar at a 0.4 point premium to the won, a reversal from a week ago when intense swapping of won to generate scarce dollars had driven the swap into a won premium.

Most traders seemed surprised by the turn in sentiment in the won markets, which by most measures were Asia's worst hit by the credit crisis.

It appeared Korea's reaching deals to expand its swap arrangements with Japan and China, announced on Friday, had calmed markets that had not responded to its heavy injections of dollar funding drawn from a credit line with the Fed.

On Tuesday, Bank of Korea injected a mere $50 million through an auction of 3-month swaps, far less than the $7 billion done in similar auctions over the past two weeks.

"We're not sure whether to credit the new bilateral swap arrangements but we think increased availability of U.S. dollars is behind the recent rise in CCS rates," ING said in a note.

Won interest rate swaps have meanwhile dived, with one-year IRS down 100 basis points in two weeks, after the Bank of Korea's rate cut of the same magnitude this month.