EUR Money Market Update

Transcription

1 EUR Money Market Update Digesting the ECB s package solution Alexander Wojt, Analyst June 9, 214

2 Executive Summary While the beyond imagination measures by the ECB were omitted last week, the package solution contains a lot of new information which will directly impact the short end of the EUR yield curve. In this publication, we take a closer look at the ECB s decisions and how they might influence money markets. The refi and deposit rate cut The ECB as expected cut both the refi and deposit rate. The negative corridor floor is uncharted territory for the bank and whether it helps to feed money to the real economy and reduce cash deposits with the ECB remains to be seen Termination of SMP sterilization By terminating the SMP sterilization, the ECB injects liquidity that could lower rates in the short end and reduce the month/quarter end volatility that has been increasing during the past half year Extending the full allotment policy An uncontroversial decision that allows financial institutions to keep borrowing unlimited amounts in the weekly MROs until at least December 216 The 4y TLTROs a 2y LTRO in disguise? With the information at hand, there is nothing that limits spending the cheap TLTRO money on peripheral bonds and close the trade 2y later (when yet to be announced conditions have to be met) The future path of excess liquidity Excess liquidity will get a boost from the termination of SMP sterilization. However, the 1bn level, where volatility tends to pick up, could be reached already in the autumn Market observations A lot was priced in before the ECB meeting but Draghi still managed to push the very short end lower As we have practically reached the bottom of the rate path, there should be little to lose by being positioned for a steeper shortend Lower money market rates will mean lower repos, and an improved carry outlook for leveraged EUR bond investors For our recent publications on the ECB, please see ECB: Still a lot to look forward to and EUR rates:deliverance! 2

3 The refi and depo rate cut The ECB as expected cut both the refi and deposit rate. The negative corridor floor is uncharted territory for the ECB and whether it helps to feed money to the real economy remains to be seen The ECB cut the deposit and refi rate by 1bps, to 15bps and 1bps, a move that was well priced in by money markets This is most likely the lower bound for policy rates. The introductory statement phrase about key rates remaining at present or lower levels wascutto present levels, and Draghi stressed that from all practical purposes, I would consider having reached the lower bound today Asexcesscashcanbeplacedontwodifferentaccountswiththe central bank (the deposit account and as excess reserves on the current account), it will earn 1bps on both The total amount to be punished with negative rates is at the moment around 13bn (Fig 1, deposit account 36bn, exc. reserves on current account 92bn) The debate regarding the negative deposit rate will likely intensify. While institutions are now charged to deposit money overnight with the ECB, the opportunity cost has not necessarily changed (e.g. 3m euribor is also down about 1bps since early May) It s no certainty that negative rates will improve lending to the real economy and lower the amount of cash placed with the ECB Low rates for too long could also be a risk for the functioning of the money market (Fig 2) In addition, the 35bps cut in the marginal lending rate will help containing EONIA spikes Fig 1. Excess cash that is to be charged with 1bps Fig 2. EONIA volume and level in vague sync Deposit facility Excess reserves EONIA, lhs EONIA volume (3m MA, bn EUR) ECB cuts deposit rate to zero Source:Nordea & Ecowin

4 Termination of SMP sterilization By terminating the SMP sterilization, the ECB injects liquidity that should lower rates in the shortend and reduce the month/quarter end volatility The decision to terminate the SMP sterilization should ease conditions in the money markets, lower the levels in the very short end and reduce liquidity related volatility The liquidity injection will be roughly 12bn from current levels (Fig 3), 16bn less the 4bn that failed to sterilize last time (Fig 4) With excess liquidity around 125bn and adding the 12bn from the termination of the SMP program, excess liquidity could reach levels around 25bn shortly Looking at the sketchy relationship between EONIA and excess liquidity, this level (above 17bn) should mean a negative EONIA (Fig 5). However, there is a range of reasons why we see this as far fetched, and we expect EONIA to remain positive. But this still serves as a tool to gauge the effects of liquidity changes Fig 4. The recent trend of SMP sterilization failures Fig 3. SMP purchases and outstanding volume Weekly SMP purchases, rhs Cummulative SMP purchases, lhs 1/1/ Fig 5. 17bn, inferred exc. liq. level where EONIA = st yr of LTRO (no repayments) -5 Overbidding SMP auctions -1 6m MA (EONIA Depo) / (Refi Depo) Exc. liq. ~ 17bn Current Data: EONIA above EONIA below Excess liquidity (bn EUR) 4

5 Extending the full allotment policy An uncontroversial decision that allows financial institutions to keep borrowing unlimited amounts in the weekly MROs until at least December 216 The fixed rate full allotment policy was extended at least until December 216 (previously mid 215) This means that financial institutions can borrow unlimited amounts in the weekly MROs at a fixed rate (the refi rate) The aim of such a measure is to curb money market volatility The decision was neither unexpected nor controversial, the policy has been extended previously The predecessor to fixed rate full allotment was the variable rate tender. Institutions could bid for an (by the ECB estimated) amount of money that was projected to be needed by the banking system However, as it got increasingly difficult for the ECB to estimate the liquidity need during the crisis and the marginal rate of allotment spiked well above the refi rate (Fig 6), the variable rate policy was replaced by the fixed rate full allotment policy Looking at the ECB s recent forecasts of autonomous factors (the most important factors deciding short term changes in liquidity), it s clear that forecast errors have lately been large, and the volatility of the error has increased (Fig 7). All else equal, this also argues for a continuation of the fixed rate full allotment policy Fig 6. The reason why fixed rate policy was introduced Fig 7. Liquidity need remains difficult for the ECB to estimate MRO spread, rhs ECB refi rate ECB marginal rate of allotment Source:Nordea & Ecowin ECB understates liq. need ECB overstates liq. -4 ECB aut fact forecast error, lhs need +/- 1 standard deviation, rhs

6 Introducing the TLTRO The Targeted LTRO is the ECB s new tool in order to improve lending to the real economy. Cheap funding will be provided if lending conditions are fulfilled Targeted Long Term Refinancing Operation (TLTRO) Aim: To improve bank lending to non financial corporations and households Size: Institutions will be able to borrow 7% of their loans to the non financial private sector (excluding loans to households for house purchases), as of April 3. This amounts to a maximum size of roughly 4bn (vs LTRO gross uptake of 1bn, net 5bn) Maturity: September 218 (4 years) Interest rate: Fixed at the refi rate at the time of the uptake + 1bps, e.g. most likely 25bps (in the LTROs it was the average refi rate over the loan period) When: The initial TLTRO will be offered twice, in September and December 214 Re fill: From March 215 to June 216, counterparties will be able to borrow quarterly up to three times the amount of the net non financial sector lending, above a specified benchmark Optional repayments: Possible after 24 months Required repayments: If certain conditions are not fulfilled with regards to the volume of net lending to the real economy, the loans will have to be repaid in September 216. The conditions have not been announced yet Fig 8. Maximum TLTRO uptake by country Fig 9. Comparison of TLTRO and LTRO volumes Core Periphery TLTRO eligible 7% of TLTRO 7% of TLTRO eligible loans DE FR IT SP NETH AU BE GR PT IR Outstanding LTRO TLTRO - LTRO Germany France Netherlands Austria Belgium Italy Spain Greece Portugal Ireland Source: Nordea, Bloomberg & Ecowin 6

7 The 4y TLTRO a 2y LTRO in disguise? With the information at hand, there is nothing that limits spending the cheap TLTRO money on peripheral bonds and close the trade 2y later (when certain lending conditions have to be met) While the effectiveness of the TLTRO will be important for the real economy, it could also play an important part in shaping the trajectory of excess liquidity and thereby have implications on the money markets With the information at hand, there is nothing that limits institutions from maximizing the initial uptake in the TLTRO, spend the money on peripheral bonds, and repay the loans two years later (when they will be forced to unless certain conditions, yet to be announced, are fulfilled) However, when asked in the Q&A about the difference between the 3y LTROs and the TLTROs, Draghi highlighted that the determination that this money not be spent on sovereigns and on sectors that are already experiencing or are just coming out of a bubbly ish situation Thus, while there is nothing that at the moment limits a 2 year carry trade, à la the 3y LTROs, the details yet to be announced with regards to the TLTRO may try to limit this kind of behavior In addition, LTRO loans could to some extent also be replaced by TLTRO loans, in particular for core banks. For Spanish and Italian banks however, the LTRO volumes are larger than the possible uptake in the TLTRO (see Fig 9 on previous page) Fig 1. Core vs periphery lending trends % of the TLTRO eligible loans Banks in the core Banks in the periphery Source:Nordea & Macrobond Fig 11. Access to finance differs between core and periphery ECB SME survey - Most pressing problem Regulation Availability of skilled staff or experienced managers Costs of production or labour Access to finance Nevertheless, while we don t expectthetltrotobeagame changer in terms of liquidity, the implications of the 3y LTROs on money markets and liquidity conditions were large, and how the TLTRO will be used should matter also for short end investors Competition Finding customers Core Periphery Source:Nordea & ECB 7

8 The future path of excess liquidity Excess liquidity will get a boost from the termination of SMP sterilization. However, the 1bn level, where volatility tends to pick up, could be reached already in the autumn The past months have shown that the draining of excess liquidity towards 1bn, through the LTRO repayments, has pushed EONIA towards the refi rate and increased money market volatility (Fig 12) The decision to terminate the SMP sterilization should increase excess liquidity to around 25bn. However, from those levels, it may not necessarily last too long before 1bn is reached again. Assuming a LTRO repayment pace of 3 1bn/week, the 1bn level could be reached already this autumn (Fig 13) As we have highlighted on the previous page, the TLTRO could also impact excess liquidity in a number of ways. If the TLTROs will be seen more as 2y LTROs, excess liquidity could rise. On the other hand, banks may switch LTRO loans for TLTRO loans and lend more money, thereby putting more pressure on liquidity draining Fig 12. Excess liquidity and EONIA Ratio EONIA and excess liquidity EURbn ECB rate.7 corridor EONIA position in ECB corridor, lhs Excess liquidity (reversed), rhs Note: 4 week moving averages Source: Nordea Markets and Ecowin Fig 13. Exc. liq. could be back at 1bn in the autumn Excess liquidity Fast repayment (1bn/w) Medium repayment (5bn/w) Slow repayment (3bn/w) Sep 14 - May

9 Market observations what s priced in? A lot was priced in before the ECB meeting but Draghi still managed to push the very short end lower ECBactionwasclearlyanticipatedbymoneymarketspriorto the meeting (Fig 14), but the package solution still managed to surprise and pushed the very front (1m EONIA) down by 4 5bps Over the coming year, EONIA is expected to drift even lower, reaching a trough around 3 5bps (Fig 15) Looking at pricing further out on the curve, a return to normality (e.g. the average refi rate since 1999) has been postponed by roughly two years since the start of this year (Fig 16) Fig 14. The ECB move was clearly priced in the short-end EONIA O/N rolling 1m avg EONIA 1m1m.5 Jan 213 May 213 Oct 213 Mar 214 Aug 214 Fig 15. Short-term pricing EONIA trough around 3-5bps Month Dates Avg EONIA Diff (bps) Cumulative (bps) Jun Jun - 8 Jul.9 Jul-14 9 Jul - 12 Aug Aug Aug - 9 Sep Sep-14 1 Sep - 7 Oct Oct-14 8 Oct - 11 Nov Nov Nov - 9 Dec Dec-14 1 Dec - 13 Jan Jan Jan - 1 Feb Feb Feb - 1 Mar Fig 16. Long term pricing return to normality postponed Mkt expectations (current) Mkt expectations (Jan 1, 214) Refi rate Lending/depo rate Average refi rate ( today)

10 Market observations how flat can it get? As we have practically reached the bottom of the rate path there should be little to lose by being positioned for a steeper short end Given the low levels of short rates, the front end curve looks, for good reasons, very flat (Fig 17). The spread between a 1y and a 1y1y EUR swap is close to zero, something that has previously only happened when the refi rate was above 4% and during the period when the ECB briefly hiked rates in 211, only to cut them shortly afterwards Looking at the US curve in comparison, 1y vs 1y1y never inverted during ZIRP, but only when the Fed Funds rate was above 5% and briefly during the Lehman collapse (Fig 19) Thus, while we find the market pricing of the ECB on the previous page fair, we see little downside in being positioned for a steeper curve in the front Fig 17. Front-end flatteners reaching the bottom yr vs 1yr1yr (eur) Refi rate, rhs Source: Nordea Fig 18. Curve and swap spreads diverging yr vs 1yr1yr (eur) -5-9 Bobl ASW, rhs Source: Nordea Fig 19. 1y vs 1y1y in the US didn t invert during ZIRP yr vs 1yr1yr (usd) 5 Fed Funds, rhs Source: Nordea 1

11 Market observations funding/repo market Lower money market rates will mean lower repos, and an improved carry outlook for leveraged EUR bond investors Repo rates have moved along with money market rates lately and the liquidity situation has thereby had a significant impact on funding costs We expect the trend of higher repo rates seen particularly since year end to turn (Fig 2). Volatility should likely also decrease This should improve the carry outlook, in particular for holding short dated EUR govies (Fig 21) Repo volumes have seen a significant rise since the LTRO repayments started (Fig 22). It s not certain to what extent this trend will continue when the TLTROs are launched Fig 2. Repo rates to head lower German repo Italy repo France repo -.1 Oct 212 Apr 213 Nov 213 May 214 Source:Nordea & RFR Fig 21. Carry of being long short-dated German bonds m carry DE govies (repo = ) -1 3m carry DE govies (repo =.15) Source:Nordea Fig 22. Will cheap ECB funding bring repo volumes lower? Period when 3y LTRO repayments not allowed 15 STOXX GC volume (bn EUR) 1 Jan 21 Dec 21 Dec 211 Nov 212 Nov 213 Oct

12 Nordea Markets is the name of the Markets departments of Nordea Bank Norge ASA, Nordea Bank AB (publ), Nordea Bank Finland Plc and Nordea Bank Danmark A/S. Alexander Wojt, Analyst alexander.wojt@nordea.com The information provided herein is intended for background information only and for the sole use of the intended recipient. The views and other information provided herein are the current views of Nordea Markets as of the date of this document and are subject to change without notice. This notice is not an exhaustive description of the described product or the risks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient. The information provided herein is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sale of any financial instrument. The information contained herein has no regard to the specific investment objectives, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is not indicative of future results. Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction. This document may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Markets. 12