* Money markets increasingly pricing in ECB depo rate cut* Such a move may have adversely impact repo markets* May also increase volatility in sovereign bond marketsBy Marius ZahariaLONDON, June 25 Money markets are increasingly pricing in a near-term cut in the European Central Bank's deposit facility rate, but some players warn that such a move may do more harm than good by lowering banks' incentives to lend. With the euro zone economy faring worse than expected, the three-year-old sovereign debt crisis intensifying day by day and waning hopes that politicians can get a definitive grip on events, markets are increasingly banking on support from the ECB. Analysts say forward euro overnight Eonia rates are pricing in an over 50 percent chance that the ECB will cut its deposit facility rate from 25 basis points to zero later this year along with its 1 percent refinancing rate. But while this would be intended to give a further push to banks to lend to each other and then to businesses to help the real economy grow, it may actually have the opposite effect. Analysts say the few banks that are willing to lend in unsecured lending markets may stop doing so as their return on such transactions may fall below the cost.
More importantly, it could create distortions in the most active sector of the money markets, repo transactions, in which investors raise cash backed by collateral, usually government debt. The rate to borrow cash using top-rated general collateral (GC), such as a basket of German or French government debt, has recemtly traded 20 basis points below Eonia, the overnight rate for unsecured lending, because of the quality of the bonds on offer. Eonia, in turn, has settled 10 bps above the deposit facility rate on average in recent months - on Friday it fixed at 0.325 percent. Once the deposit rate is cut to zero, Eonia is expected to fix at around 0.1 percent.
"That would mean that the GC rate will be negative, limiting the ability to get money using the bonds. It can create a distortion in the repo market," said Alessandro Giansanti, rate strategist at ING. BOND MARKET IMPACT Any repo market distortion could also lower volumes in sovereign bond markets, as investors who buy government debt to raise cash will no longer have a reason to purchase them.
"This could add to the negative momentum observed in sovereign bond markets, which is reinforced by increased volatility and already impaired liquidity," Commerzbank rate strategist Benjamin Schroeder said in a note."Within the context of the broader sovereign crisis, it would be worrying if the ECB risked endangering the still very fragile bond markets in return for questionable positive effects for interbank lending."Not all analysts are worried that a cut in the deposit rate will have side effects on repo markets. Max Leung, a rates strategist at Bank of America Merrill Lynch Global Research, said repo rates on a few German bonds - posted as collateral individually rather than as part of a basket - have already turned negative and volumes have not dropped."Negative rates is never a good thing because you penalise people for lending, but there are securities which are already trading at negative levels because of flight-to-quality flows," Leung said."As far as banks are concerned it still represents business. For the repo desks, they can still charge relatively wide bid/offers so we don't think volumes will necessarily fall because of that."
Interbank dollar funding costs extended their declines on Tuesday, reflecting little demand from European institutions for dollar-based funds as lending activity in the interbank market was also scarce. The European Central Bank's three-year loan operations have replenished bank funds with over 1 trillion euros since December and reduced their need to borrow in the short-term interbank debt market, where traders say there is virtually no lending. The three-month London interbank offered rate, which is based on the level banks report they can borrow, declined on Tuesday to 0.47065 percent from 0.47265 percent on Monday. The rate, which is used as a benchmark for interest rate swaps and other rate products, is down from a high of over 58 basis points at the end of the year, though still much higher than the 25-basis-point level that it had traded at in mid-2011."The European entities have plenty of euros now. It's a question of whether they need any dollars to fund their dollar assets," said Jim Lee, head of short-term rates strategy at RBS Securities in Stamford, Connecticut.
EUROPEAN BANKS CUT DOLLAR OBLIGATIONS U.S. money market funds have been stepping back into the market and are lending to more countries at longer maturities after pulling back dramatically last year, leaving French banks grasping for funds needed to fund their dollar-based businesses.
At the same time, European banks have reduced their dollar obligations, reducing their need for funds in the currency. The premium charged to swap three-month euros into dollars in the currency swap market also fell to 54.5 basis points on Tuesday, the lowest rate since last August, reflecting little need for dollar funds. The rate came under extreme stress late last year as European banks struggled to raise the loans, which was one factor behind coordinated action by central banks to offer banks cheap loans.
The largest risk for European banks is if sentiment changes and banks are unable to refinance maturing loans as they come due in the coming month, said Lee of RBS. One headline risk is that Moody's Investors Service currently has 15 of the largest investment banks under review for a ratings downgrade. The rating agency said it expects to conclude the review in mid-May. Bank-to-bank Euribor rates also fell below 0.80 percent for the first time since July 2010. The pace of decline is seen slowing as it heads toward record lows. With the European Central Bank poised to keep refi rates on hold for a while, analysts increasingly see three-month Euribor rates stabilizing around 63 bps - record lows hit in March of 2010. It fell to 0.79 percent on Tuesday from 0.80 percent in the previous session. At record lows, Euribor rates would still offer roughly a 30 bps premium over the overnight Eonia rate, which stood at 0.35 percent in the previous session. The Eonia rate in turn provides a pick-up over the ECB's deposit facility rate of 0.25 percent.
Aug 13 A fresh injection of long-term ECB loans into the banking system could worsen a shortage of Spanish government bonds in the repo market, further squeezing a source of short-term funds for Spain's banks. Traders said a distortion of prices in the Spanish repo market that followed a 1 trillion euro flood of three-year European Central Bank loans in December and February could be exacerbated if the bank repeated the operation. Spanish government bonds have been in short supply in the repo market, where banks commonly use them as collateral to raise funds, since domestic banks parked them at the ECB in return for cash -- particularly the three-year loans. This prompted investors who need the bonds because of their own short positions to pay a premium for the paper. In a normal repo operation, the party needing the cash would pay the premium but in the distorted Spanish market, it is the other way round."In Spain there're a lot of short positions in the market...and we're seeing the repo levels around -3 or -4 percent," a repo market trader said. A negative number means the borrower is effectively being paid to take the lender's cash."As soon as the repo market gets to be like that, it stops functioning effectively and that has a knock-on effect in the cash market because you can't provide liquidity to clients," the trader said.
ECB President Mario Draghi said earlier this month the ECB would discuss loosening its collateral rules further in September and could repeat other measures such as its long-term cheap loans, known as LTROs."Perversely if another LTRO came in and there was a big take-up by Spanish banks and they put Spanish bonds in, the repo market could get worse," another trader said."This is contributing to the decline of the cash market because you need the repo to oil the wheels in the cash market."Banks can repay the ECB's initial three-year loans after 12 months, but as the three-year-old sovereign debt crisis rumbles on with Spain now on the front line, analysts expected reliance by peripheral banks on the central bank to remain high.
Spanish banks' reliance on ECB loans has increased in recent months as it has for Italian banks. But unlike Spain, the Italian repo market is still functioning normally, supported by the deeper liquidity in the country's debt market.
Uncertainty over how efficient promised ECB intervention in bond markets would be in lowering Spanish and Italian borrowing costs, as well as over final details of a bailout of Spanish banks of up to 100 billion euros agreed with the European Union last month, was also keeping repo investors on edge."On the whole the repo market in Spain has deteriorated much faster with the Spanish markets under pressure. You need the sovereign market to be more liquid," said Elaine Lin, a strategist at Morgan Stanley."Immediate improvement is unlikely for the Spanish sovereign or the banking sector given their close link and the capital injection
* Cheap ECB loans seen as reliable shield against Greek mess* Rates still falling, but trading becomes more "name specific"* Some small signs of interbank stress show upBy Marius ZahariaLONDON, Feb 16 The hefty amount of cash floating around in the euro banking system is generally offsetting fears that a potential messy Greek default could severely hit lenders across the bloc, but tentative signs of stress in the interbank lending market are emerging. Worries that Greece may not get a second bailout are making banks more reluctant to lend to each other again, with traders saying bank-to-bank lending has turned even more "name specific" in recent days, meaning only the strongest banks were active. Benchmark interbank rates continued to fall, with the European Central Bank's injection of nearly half-a-trillion euros into the banking system last year providing comfort. Banks can also take as much of the extra cheap loans as they want at a similar tender at the end of the month. But some signs of stress can still be spotted.
The Markit iTraxx index of credit default spreads for European senior financials - measuring the cost of insuring against a bank defaulting on its debts - has risen by almost 50 basis points in the past 10 days to above 240 bps. But it was still more than one full point below the highs seen in November before the ECB first announced its three-year funding plans."The chance of a liquidity squeeze has been (lowered) but you cannot fully neglect the chance of default from a bank which has exposure to a peripheral country, not only to Greece," said Benjamin Schroeder, rate strategist at Commerzbank."Interbank risks are obviously increasing. If you think contagion can get out of hand problems in interbank markets could (appear) again."
He also said spreads between forward rate agreements and overnight index swaps (OIS)-- a widely used measure of stress in the interbank lending markets -- could re-widen if Greek tensions increased. Morgan Stanley strategist Elaine Lin said the euro Libor/OIS spread, now at 62 basis points, could expand towards 100 bps in case of a disorderly default, levels last seen in early 2009 after the shock of the Lehman Brothers collapse. Another stress measure that is widely used, the cost of swapping euro interest payments on an underlying asset into dollars as measured by the three-month cross currency basis swaps, widened by 4 bps to minus 79.5 bps.
That is still less than half the levels seen in November and some of the widening presure in cross currency markets may also have been triggered by expectations that the Dutch State Treasury may want to swap some of the around $3 billion worth of its first dollar bond being sold on Thursday into euros. ENHANCED FIREWALL Interbank rates maintained their downward trend. The three-month London Interbank Offered Rate for euros, or Libor , dropped to 0.96821 percent on Thursday versus 0.97821 percent on Wednesday. Equivalent Euribor rates also fell"Contagion will be higher in a blowout scenario," Lin said, adding that markets are still expecting the Greek situation to be dealt with in an orderly fashion."But the fact that the ECB is doing the (three-year lending) and the fact that we are at a juncture of doing another one or even the likelihood of an outright QE (quantitative easing) tends to enhance the firewall."As long as a chaotic default is not the main scenario the impact on money markets should be minimum, because "banks' balance sheets have almost written down the entire Greece holdings and U.S. exposure has wound down to minimum", she said.
* Euro zone banks hoard record amounts of cash* Overnight borrowing reflects dislocation* Money market tensions not seen easing muchBy Kirsten DonovanLONDON, Jan 3 The euro zone banking system starts the new year awash with record levels of liquidity but few signs that institutions are prepared to lend to each other, leaving money markets frozen. Most of the near half trillion euros of three-year funds borrowed from the European Central Bank in the last week of 2011 have made their way back to the ECB's overnight deposit account. Use of the facility was close to 450 billion euros on Monday night. But, reflecting the dislocation in short-term funding markets, at least one other bank borrowed 14.8 billion euros from the ECB's punitively priced emergency lending facility.
What happens to the excess liquidity in coming weeks will be key. But with banks facing heavy refinancing schedules this year, those looking for a revival in money markets may be disappointed."My sense is that we will see some easing of tensions, but that's a natural seasonal thing," said Simon Smith, chief economist at FxPro."But it's unlikely to be that substantial because of the bank refunding that needs to be done and the three-year money was in part intended to help with that."Benchmark three-month euro Libor rates fixed a basis point lower at 1.26857 percent, and down around 6 basis points since the injection of three-year funding.
But the spread over equivalent maturity overnight indexed swap (OIS) rates has barely budged - it stands just a couple of basis points lower at 88 basis points - and RBS said there is unlikely to be a material tightening."The reduction of tail risk for banks, where the ECB has effectively backstopped the system reduces counterparty risk to the extent a Lehman type event is a lower probability," strategist Harvinder Sian said."Until the sovereign risk is reduced (spreads) are unlikely to trend narrow - and our view remains much more cautious in that sovereign defaults are likely in 2012, starting with Greece."
Concern over banks' exposure to the sovereign debt crisis has closed money markets and longer-term financing markets. Societe Generale calculates that the roughly 200 billion euros in extra funding available to banks since the three-year tender only corresponds to an estimated financing gap for 2012 based on longer-term debt redemptions and deleveraging. Even with another three-year tender in February, that means banks are unlikely to use the cash to buy euro zone government bonds, the so-called carry trade, anticipation of which drove shorter-term Italian and Spanish bond yields sharply lower at the end of the year."Banks are torn between using cheap borrowing to boost profits and intense market and regulatory pressure towards deleveraging," SG analysts said."We continue to believe that the latter is too strong a force. The large (three-year cash) take-up should reduce the speed of asset selling, but we doubt it will lead to aggressive buying of sovereign bonds."Banks did, however, cut their take-up of one-week ECB funding by just under 15 billion euros on Tuesday , although it is quite usual to see a reduction in such borrowing as the monthly maintenance period advances.
* ECB refinancing and deposit rates seen unchanged this week* December's enthusiasm for deposit rate cut erased* Traders poised to act on any signals of future cutsBy William JamesLONDON, Jan 7 A risk-hungry start to the year means traders are not positioning for the European Central Bank to cut interest rates on Thursday, but sensitivity to any signals on future cuts will remain high. After a roller-coaster December, in which expectations of a cut to the central bank's deposit rate built up and were subsequently dashed, pricing suggests traders are betting on a wait-and-see approach from the ECB in January."My feeling is that the pressure to cut has eased a bit... a negative deposit rate is no longer priced in," said Elwin de Groot, market economist at Rabobank in Utrecht."After the last meeting we saw the market positioning themselves for one more rate cut into January. Since then the market has come away from this view and now it is not so strongly positioned any more for a near-term cut."
A Reuters poll showed 67 out of 73 economists expected the main refinancing rate to remain at 0.75 percent. The refinancing rate at which the central bank lends money is the main tool used to encourage bank lending and boost the economy. But banks are already flooded with cheap ECB loans, meaning the deposit rate charged on excess reserves has a more significant impact on short-term interbank borrowing costs. Forward rate agreements, used to bet on where the Eonia overnight borrowing rate will be in the future, have recovered from a steep fall last month that was triggered by ECB President Mario Draghi revealing a deposit rate cut had been discussed.
Other ECB members have since played down the likelihood of a cut, driving a rally in Eonia forwards. The contract linked to the July ECB meeting now trades at 0.057 percent, having hit a low of -0.054 percent in the December fall. SENSITIVITY REMAINS The ECB has repeatedly been pressed into action by Europe's worsening debt crisis over the last three years, but has bought some calm with its latest, as-yet untested, promise to buy bonds issued by states that seek an official bailout. Expectations that rates will be left unchanged after Thursday's meeting are supported by the strong start to the year for risky euro zone bonds after a late deal to avert a fiscal crunch in the United States.
"Since the December meeting, the economic situation in the euro zone has stabilised and the mood in the financial markets has improved, especially after the agreement in the U.S. to avoid the fiscal cliff," Barclays Capital analyst Giuseppe Maraffino said in a note to clients. Barclays had previously forecast a cut in January but now expects rates to remain on hold, with the ECB leaving itself open to a cut in the future. Economists' forecasts on the bank's next move after January were split, with a slim majority expecting no change to interest rates in the first quarter of the year, the Reuters poll found. Nevertheless, the fact that few are expecting a cut to either of the bank's key rates on Thursday means markets will be sensitive to any insight into the bank's thinking on whether policy could loosen in the future, analysts said."Given the developments of the last four weeks or so, any slightly dovish language could give the market a bit of a turnaround," de Groot said. That effect would be felt in both Eonia forwards, which fall on speculation about a deposit rate cut, and a rise in Euribor futures which also incorporate the markets view on the refinancing rate outlook.