By Richard Leong and Kirsten Donovan
NEW YORK/LONDON (Reuters) - U.S. short-term borrowing costs edged up on Thursday on concern the Federal Reserve could signal it is ready to tighten monetary policy sooner than traders had thought.
The biggest increase was in U.S. forward rates, as nearby rates futures rose for a second day in the wake of a report that said Fed policy-makers were divided on when to begin raising interest rates.
Medley Global Advisors, an influential hedge fund consulting firm, issued its report on Wednesday in advance of a two-day meeting of the Federal Open Market Committee, the Fed's policy-setting group, next week For more, see [ID:nN16135215]
"The sell-off at the front end shows some nervousness over what the FOMC might say about draining liquidity from the banking system," said Christian Cooper, an interest rate strategist at RBC Capital Markets in New York.
The decline in front-end federal funds futures suggested traders are pricing a greater, though still remote, likelihood the Fed could begin raising rates in the first half of 2010.
Deferred rates futures however rose in a rebound after data in housing, jobs and regional manufacturing stoked the perception the economy has not bottomed yet.
"The proof is not in the pudding," RBC's Cooper said of the day's data failing to support the notion of a recovery.
In London, interbank rates on dollars rose with the exception the three-month rate which held at its record low of 0.29188 percent for a second day.
The spread between three-month dollar London interbank offered rate (Libor) and equivalent Overnight Indexed Swap rates edged up 1 basis point to 13 basis points. This Libor-linked risk premium was still near its narrowest since the third quarter of 2007 when the global credit crisis began.
Another Libor spread, the TED spread, grew 1 basis point to 19 basis points.
In other currencies, the three-month Libor on euro rates were steady at 0.72375 percent, while three-month sterling Libor fell to 0.58563 percent.
U.S. MONEY FUND BACKSTOP TO EXPIRE
As credit markets have improved since the collapse of Lehman Brothers a year ago, some programs created by the U.S. government during the financial crisis are coming to an end.
On Friday, the Treasury's Temporary Guarantee Program for Money Market Funds will expire.
Last September, investors pulled money out of money market funds after Primary Reserve Fund, then one of the biggest of these funds, reported its share fell below $1, or "broke the buck" due to massive losses on its Lehman investments.
The federal money market guarantee program allows fund operators to protect their shares from breaking the buck. The Treasury received applications to back at least $3 trillion in money market assets.
There have been evidence some investors have been shifting money from money market funds ahead of the expiration of the guarantee program to bank accounts, analysts said.
But the outflows from money market funds have been muted, they added.
"We think this may be a non-event," James Caron, head of global rates research with Morgan Stanley, wrote in a research note published on Wednesday. "People seem not worried about systemic risk currently. This reduces pressures on money market accounts."
(Reporting by Richard Leong)