By Richard Leong and Jonathan Spicer
NEW YORK (Reuters) - Key short-term interest rates jumped on Thursday as international markets calmly responded to the Federal Reserve's first policy tightening in nearly a decade, a welcome sign for the U.S. central bank as it prepares for a tricky auction later in the day.
Libor, a global rate benchmark for $350 trillion worth of securities and loans, booked its biggest single-day rise since May, 2010, while a key borrowing cost for Wall Street firms more than doubled in the wake of the modest U.S. rate hike.
Moves in the Treasury market were modest, the dollar rose as expected, and world stocks broadly applauded the well-telegraphed move by the Fed.
"The Fed has to be patting themselves on the back given what's happened in markets," said Andrew Szczurowski, portfolio manager at Eaton Vance, in Boston. "With all of their transparency they managed to pull any volatility forward (before the hike), so I'd say it's a success."
The world's most influential central bank decided on Wednesday to raise its key policy rate modestly to a new range of 0.25 to 0.5 percent, in a nod to U.S. labor market strength and the expectation that inflation is around the corner.
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The heavy lifting comes on Thursday as the Fed uses new tools to pry borrowing costs off the floor. After seven years of unprecedented low rates and Fed bond buying, banks are flooded with some $2.6 trillion in excess reserves that makes it far more difficult than in the past to pull off a rate hike. [ID:nL1N1441IT]
To ensure rates rise as high as desired, Fed policymakers aggressively expanded a so-called overnight reverse repurchase program, or ON RRP, effectively ditching a cap on the facility and putting up to $2 trillion of its Treasury bonds up for daily auctions.
The reverse repo facility, which should mop up the excess reserves, was previously capped at $300 billion in what was largely a test phase. Analysts had expected the Fed to about double it when it hiked rates.
"It's clear the Fed is going to do what ever it takes," said Szczurowski.
The Libor measure of interbank borrowing costs rose 0.04 percent on Thursday. But it is up more than 0.20 percentage point since November as investors anticipated the U.S. rate hike, and as lending diminished toward year-end.
In the $5 trillion repo market, the overnight interest rate for Wall Street banks to borrow from money market funds and other cash investors rose to 0.43-0.47 percent, from 0.20 percent late Wednesday, according to ICAP data.
Also on Thursday, rate futures markets slipped as traders expected the Fed would follow up with another rate increase by mid-2016.
But in the early stages of the tightening cycle, trading was muted in relatively calm markets.
"Everybody's looking around hoping and waiting for more traction, more activities and more flows," said Joe D'Angelo, head of money markets at Prudential Fixed Income, in Newark, New Jersey. "Most issuers are still trying to get things done at around the same levels before the rate increase."
From its "operations room" three blocks off Wall Street, traders at the New York Fed will run the first post-liftoff auction between 12:45 and 13:15 Eastern (1745-1815 GMT).
The reverse repo rate will be set at 0.25 percent, up from 0.05 percent, and serve as the "floor" to the new target policy range. A rate the Fed pays primary dealers on excess reserves, also a relatively new tool, will serve as the "ceiling" at 0.5 percent.
The real test for the Fed may come in the weeks ahead as market liquidity dries up and investors close down trading positions toward year end. Banks also curb short-term lending on the last day of the quarter.
"It could be well into January before the Fed gets the daily amount of the RRP program perfectly calibrated," said Carl Tannenbaum, chief economist at Northern Trust and a former Chicago Fed official.
(Reporting by Richard Leong and Jonathan Spicer in New York; Additional reporting by Dhara Ranasinghe in London; Editing by Nigel Stephenson and Chizu Nomiyama)