Libor to Decline on Liquidity Programs, Gross Says (Update1)

By Thomas R. Keene and Daniel Kruger

Oct. 17 (Bloomberg) — The cost of borrowing in dollars in London will decline about 2 percentage points as the U.S. begins implementing programs to buy short-term debt from corporations and distressed securities from financial institutions, said Bill Gross, who manages the world’s biggest bond fund.

“We’re talking weeks here,” said Gross, in an interview on Bloomberg Radio from Newport Beach, California, where he serves as co-chief investment officer for Pacific Investment Management Co. and runs the $129.6 billion Total Return Fund. “I think it happens when these programs are implemented and we begin to see some flow as opposed to simply some news.”

London interbank offered rates, or Libor, and other money market rates began to decline this week after central banks agreed to make direct capital infusions in banks and joined forces to offer lenders an unlimited supply of dollars and euros. The U.S. government program created last week to buy three-month commercial paper to provide a liquidity backstop for companies begins the week of Oct. 27.

Gross estimated that one-month dollar Libor will drop to about 2.25 percent from 4.18 percent today, and three-month borrowing costs to 2.65 percent from 4.41 percent.

While the reliability of the Libor-setting process has been criticized amid the global credit squeeze, it’s used to determine rates on $360 trillion of financial products worldwide, from mortgages to company loans and derivatives.

Libor-OIS

The Federal Reserve said Oct. 7 that it would buy commercial paper to alleviate short-term funding pressures afflicting companies after rates for the loans reached as high as 3.95 percent on Sept. 30, nearly twice the 2.13 percent average for the past six months.

Lending between banks, which slumped after the collapse of the U.S. subprime-mortgage market last year, all but seized up after Lehman Brothers Holdings Inc. went bankrupt Sept. 15.

The Libor-OIS spread, which measures the difference between the three-month dollar rate and the overnight indexed swap rate, was at 332 basis points today, up from 24 basis points on Jan. 24. The average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.

Overnight indexed swaps are over-the-counter traded derivatives in which one party agrees to pay a fixed rate in exchange for the average of a floating central-bank rate during the life of the swap. For dollar swaps, the floating rate is the daily effective federal funds rate.

Government Guarantees

The Treasury’s support for short-term bank debt has widened the spread between the debt of government sponsored enterprises and Treasuries because “a government guarantee is slightly better than an agency,” Gross said.

That has led to 6 percent yields on Fannie Mae and Freddie Mac mortgage debt, compared with a yield below 4 percent on 10- year Treasuries shows “the difference in the attractions” of the securities, Gross said.

The Treasury will choose five to 10 firms to help it buy troubled securities. BlackRock Inc., Legg Mason Inc. and Pimco informally advised the U.S. in the days leading up to the passage of the plan and want to manage some of the assets before selling them, according to people familiar with the matter, who asked not to be identified because the discussions were private.

Pimco has bid on various roles managing assets and has been picked for the Fed’s commercial paper program, Gross said.

Total Return Fund

Since Oct. 3 when President George W. Bush signed the $700 billion financial rescue package, known as the Troubled Asset Relief Program, Treasury Secretary Henry Paulson has said the government will invest $250 billion in the preferred stock of nine firms in order to unclog the credit markets and revive lending.

The TARP plan also includes the three-year government guarantee of senior bank debt sold after the law’s passage.

Gross’s Total Return fund has returned 4.4 percent annually over the past five years, beating 99 percent of its peers in the government and corporate bond fund category as of Oct. 16, according to Bloomberg data. Pimco, a unit of Munich-based Allianz SE, has $840 billion of assets under management.

To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: October 17, 2008 12:28 EDT

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