* Dollar interbank rates hit fresh low in Singapore
* Swaption short-term vols inch up as swaps turn higher
* Bank failure fears also raise risk, widen FRA-OIS spread
By Vidya Ranganathan
SINGAPORE, Sept 2 (Reuters) - Dollar interbank rates fell to record lows in Singapore on Wednesday in spite of a slight pick-up in interest rate volatilities and wider spreads as fresh fear over bank failures caused financial stocks to fall.
Private equity and hedge fund Cerberus Capital Management, which has been hit hard by investment losses, on Tuesday dismissed rumours it is in danger of default.
But trading in Asia continued to be dogged by fears that a major bank or a hedge fund would fail, a factor that has played a part in driving U.S. stock markets down three days in a row.
That in turn has driven up realised volatility in short-term U.S. rates, as bonds climbed and yields fell alongside falling stock markets this week. Over the past two weeks, 2-year U.S. Treasury yields have climbed to as high as 1.06 percent from 1.02 percent and before falling to 0.91 percent on Tuesday.
Two-year U.S. interest rate swaps have fallen 7 bps this week to 1.27 percent, while realised volatility on that swap has climbed to 66 percent from 42 in a week.
"There has been fair bit of move in Treasuries recently," said a trader in Singapore. That is why we're seeing 1-month options moving higher in terms of premium and realised volatility moving up.
"Gamma comes off if rates are rangebound, which has been the case for a while now, until the past 1-2 days." Gamma relates to day-to-day fluctuations in short-term rates.
Implied volatilities on dollar swaptions have risen. The one-month option on a one-year swap has an implied volatility of 109.5 percent, far higher than levels of 96 percent last week. In normalised terms, that option has a 4.3 bps per day volatility and premium was 0.5 bps higher than Tuesday at levels between 15.2 and 15.7 bps.
The FRA-OIS spread, the spread between forward expectations of interbank rates and expectations of policy rates, has simultaneously widened to 17 bps for 3-month rate contracts starting after one month from as low as 13 on Monday.
Meanwhile, the abundance of cash in money markets continued to drive lending rates down. In Singapore, 3-month dollars fell half a basis point from Tuesday to 0.344 percent, nearly half the levels in May.
Eurodollar futures also moved higher, with December eurodollar futures pricing 3-month LIBOR at 0.475 percent.
The spread between LIBOR and overnight-indexed swaps (OIS), the latter a measure of market expectation of policy rates, narrowed to 16 bps, a level of tightness last seen in late 2007.
"Essentially, there is an incredible amount of short term liquidity for banks and some rate investors believe the spread between LIBOR and OIS could get to record levels in the near future," Barclays Capital said in a note. (Editing by Kazunori Takada)