(Adds details on Fed balance sheet changes)

NEW YORK, July 2 (Reuters) - The U.S. Federal Reserve's balance sheet shrank below $2 trillion for the first time since early March in the latest week, signaling less strain in the financial system, Fed data showed on Thursday.

The Fed's balance sheet liabilities -- a broad gauge of its lending to the financial system -- contracted to $1.989 trillion on Wednesday from $2.010 trillion a week ago.

This is the smallest since March 11 when its balance sheet stood at $1.882 trillion.

The decline in the U.S. central bank's assets stemmed from fewer overnight loans to banks, less dollar lending overseas and a drop in commercial paper holdings.

Overnight direct loans to bank via the Fed's discount window averaged $118.88 billion per day in the latest week, lower than $123.70 billion a day in the prior week.

The Fed's liquidity swap lines with foreign central banks to provide dollars averaged $115.30 billion per day in the latest week, down $6.29 billion per day from prior week's average, according to Fed data.

The Fed's Commercial Paper Funding Facility assets totaled $114.69 billion on Wednesday, lower than $124.03 billion a week ago. The decrease in this backstop for this type of short-term corporate IOU reflected an increase in companies choosing to issue longer-term debt to lock in financings in the current low-rate environment, according to analysts.

Earlier Thursday, the Fed reported commercial paper outstanding fell to its lowest level in at least 8-1/2 years to $1.136 trillion in the week ended Wednesday. [ID:nNYG001564]