Euro liquidity and the implications for cash-collateral
Posted by
Izabella Kaminska on Oct 04 12:40.
According to Bloomberg data, there’s been an interesting development in the euro swaps curve over the last week.
As can be seen below, the very front end of the curve has inverted ever so slightly:
A persistent inversion of this sort — we are told — usually reflects changing rate expectations, towards a more hawkish stance from the ECB.
Hence, this is partly the result of last week’s Long-Term Refinancing Operation (LTRO) rollover, which saw borrowing at the European Central Bank decline sharply and with that short-term rates, such as Eonia (Effective Overnight Index Average), spike higher.
According to Barclays Capital, for example, the liquidity surplus in the eurozone banks now stands at about €31bn, from €108bn the day before the rollover.
And as they note:
We expect it to remain low in the coming months, thus creating the potential for an increase in the EONIA towards 1%. Next week the focus is on the ECB’s meeting. We do not expect the ECB to announce any form of exit strategy, even if the latest comments by some ECB officials hint they are in the process of phasing out some of them.
Another side-effect has been on the European repo market, as Barclays continues:
http://av.r.ftdata.co.uk/files/2010/10/Euro-repo.jpgRepo market: Rates have increased after the surprising decline in theiquidity surplus in the Eurosystem.
The repo market is trying to find a new equilibrium in the new context of very strict liquidity conditions. This should be a potential source of volatility in the repo market in the next few days.
In short, Barclays says the market has returned to the early 2008 environment, when a small liquidity surplus was apparent. This should, theoretically, begin to put presure on Eonia and other short-term rates.
Of course, there is also one other potential side-effect. Since the crisis, traders have been incorporating
additional factors into the pricing of European funding operations, including in some cases, a greater reliance on US rates in situations when USD-denominated collateral has been used or there is USD exposure.
This follows in the footsteps of a new pricing model which already incorporates a “risk free rate” based on the overnight cash collateral rate (OIS or Eonia,
rather than the three-month rate).
The Centre for Advanced Research in Finance, for example,
recently noted that cash collateral was becoming increasingly popular partly because it was free from the issues associated with rehypothecation, and the required time for settlement is shorter than other assets, such as government bonds.
Given the above, any divergence between US and European rates can suddenly have a bearing. And this, for example, is the most recent dislocation:
Worth watching, especially since sharp exchange rate fluctuations may have a bearing on this too.