Market Economics | Interest Rate Strategy - BNP PARIBAS ...

EUR: Liquidity is No Stress
• The reserve maintenance period started with
a lower level of liquidity, fuelling concerns of
potential tension on eonia.
Chart 1: Excess Liquidity has Declined
• However, with no stress on liquidity given
the ECB’s pipeline for the next few months,
tensions will remain limited. The eonia curve will
resteepen over the next couple of weeks.
• STRATEGY: Take advantage of a flattening
correction on ERs to re-enter bear steepeners.
Lower demand at the ECB…
Demand at this week’s ECB tenders fell slightly short
of levels expiring. The ECB allotted EUR 247.3bn
while EUR 248.2bn were maturing. This was a little
surprising as demand usually increases during the
first week of the reserve maintenance period. Indeed,
banks usually hold more than reserve requirements
in their current accounts during the first part of the
reserve period, in order to avoid the risk of running
out of cash before the period ends. In such a context
and given lower liquidity, there was the risk of
tensions on eonia beyond the usual rise on the last
day of the previous reserve period.
…as long as the ECB pipeline remains open
The lack of stress apparent in banks’ demand at ECB
tenders can be explained by the fact that near term,
i.e. at least until April, the ECB will continue to
provide liquidity on request without any cap. There is
therefore no hurry to ask for a large excess of
liquidity. In addition, it seems that banks adjusted
their level of excess reserves at the start of the new
reserve period. They currently hold EUR 222bn in
their current accounts (EUR 9.7bn above
requirements), while excess reserves are usually
closer to EUR 40-50bn at the start of the period.
Moreover, while demand at the MRO fell, demand at
the LTRO (3 weeks) rose. This will prevent stress
from developing.
A gradual resteepening at the front end
Beyond the first couple of days at the start of the
period, it makes sense that eonia should decline.
This will go along with a steeper spot eonia curve.
Steepening pressures will also resume on the ER
curve. After last week’s ECB press conference, the
ER1-ER steepened 15bp under selling pressures.
From a peak of 75bp, the spread tightened back to
72.5bp. Over the next few days, the potential for a
bull-flattening correction on ERs will fade. The
regime at the front end has changed. For sure, the
ECB did not want to flag up the risk of a rate hike
Source: BNP Paribas
Source: BNP Paribas
Chart 2: Excess Reserves Lower
over the next few months. But the ECB is gradually
reassessing risks. Last year, bear-steepening
movements at the front end offered bull-flattening
trade opportunities. This year, the opposite is true.
The current movement on the Euribor curve is
temporary. A flattening below 70bp along with an
ERH2 close to 98.25 offers an opportunity to re-enter
bear steepeners. It is worth noting that, over the long
run, the average spread between the refi and the
3mth Euribor is 15-20bp in a status quo, rises to
35bp ahead of a rate hike cycle and is close to 50bp
when the rate hike process starts. As long as the
market discounts a rate hike by early 2012, the
Mar12 implied rate must be at least 1.75%.
Strategy: Beyond a near-term correction, there is no
scope for a bullish bias on ERs. Benefit from a bullflattening
correction to re-enter bear steepeners.
Patrick Jacq 20 January 2011
Market Mover, Non-Objective Research Section
39
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