It's not over.

Drama unfolding deep in the bowels of the financial system looksset to continue after a brief pause in August, according to newanalysis from TD Securities (USA.

The London Interbank Offered Rate known as Libor surging from61 basis points at the start of the year to 84 bps at theend of August, the highest since the financial crisis. Themove comes ahead of the Oct. 14 deadline for reform efforts thatwill see money market funds — a $2.7 trillionmarket that forms an important source of short-term fundingfor banks — build up so-called liquidity buffers and installredemption gates, among other measures.

The looming deadline means that prime money market funds, whichtypically buy the short-term IOUs known as commercial paper issuedby banks and other companies, have been shiftinginto government securities in anticipation of investorredemptions or as they try to build up the liquidity buffers thatwill be required in just over a month's time.

The exodus has helped push up the cost of corporate and bankfunding earlier in the year, sending CP and Liborrates soaring.

After a brief moderation in August, the trend looks set tocontinue, according to TD analysts led by Priya Misra.

They point to a divergence between stabilizing money marketrates and the still-rising cost of obtaining U.S. dollarfunding through the derivatives market. While risingcommercial paper rates and Libor have stalled in recent weeks, thecost of swapping currencies such as the yen or euro into U.S.dollars using the so-called cross-currency basis swap has increasedto as much as 155 bps and 116 bps, respectively, suggestingcontinued strains in the dollar funding market as banksscramble to replace a funding hole left by exiting prime moneymarket funds.

“Even though commercial paper rates have not risen over thelast few weeks, the implied cost of unsecured dollar financinghas increased steadily according to the cross-currency basisswap market or the FX forwards market. These levels are almostall higher than the Libor fixing [which currently stands at 84bps],” the analysts said in a note published late Wednesday. “Whilethe two markets are not identical and there are differences interms of domestic funding costs, margins and credit lines with thebasis swap market, we believe that these higher implied rates hintsat the ongoing pressure for dollar financing by non-U.S.banks.”

TD expects $200 to $300 billion to leave prime money marketfunds before Oct. 14, which could help fuel further increases inLibor. Higher money market rates would mean a tightening offinancial conditions even if the Federal Reserve opts not to raisebenchmark U.S. interest rates in September, with far-reachingconsequences for players as varied as big Japanese banks dealingwith dollar funding costs, U.S. homeowners, and companies inemerging markets such as China.

“Over time we believe that these two markets should converge,implying that Libor should fix higher,” the TD analystsconcluded.

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