Market Outlook - BNP PARIBAS - Investment Services India

EUR: Eonias Bet on July Jump
• After having eased from levels seen at the
start of the year, ECB meetings are gradually
gaining ground.
• The biggest step remains between June and
July, as the prospect of the EUR 442bn expiry
weighs significantly.
• STRATEGY: Receive May-July gap, pay Aug-
Oct gap.
ECB’s focus is on EUR liquidity
The ECB is stopping temporary swap lines with the
Fed, as well as stopping USD liquidity operations
with EMU banks. At the prospect of the end of these
operations, demand for dollars at the ECB’s weekly
tenders has plunged in recent weeks, reaching zero
this week. What we have seen over the past few
weeks is less demand at the ECB’s USD tenders and
more at the MRO. The ECB allotted EUR 63.4bn at
this week’s MRO, with EUR 58.0bn maturing.
Demand for 1-week liquidity remained close to levels
seen in previous weeks. The number of bidders (83)
was significantly down from last week (101). The
decrease in the number of bidders is a sign of
normalisation for most banks but also indicates that
there is no significant improvement at struggling
banks. After this week’s tender, liquidity provided to
the eurosystem with open market operations was
almost unchanged and remained very high – close to
EUR 760.0bn (EUR 725bn through OMOs and EUR
33bn from the covered bond purchase programme).
This is around EUR 190bn above current needs. In
other words, excess liquidity increased slightly and
this prevented any tension on fixing from developing.
Liquidity expected to remain excessive until June
Current excess liquidity conditions will persist for a
while. Even if demand at the MRO collapses in
coming months, liquidity provided by the three 1y
tender accounts for EUR 614.4bn, still above
expected daily requirements (in the EUR 580-610bn
area). This will continue until the end of June. At this
stage, there are two major uncertainties. What will
the ECB decide with regard to short-term open
market operations while it is gradually removing the
1y and 6mth tenders? And how to deal with the
collapse in liquidity at the end of June?
It is worth bearing in mind that the ECB wants to
drive the “exit strategy” in order to 1/ drain the excess
liquidity and 2/ change the structure of funding –
currently, open market operations at 9% with MROs
and 91% with LTROs – to the structure prevailing
before the crisis, i.e. 60-65% with MROs and 35-40%
billions
350
300
250
200
150
100
50
0
Chart 1: Liquidity Remains High
Liquidity provided by Open Market operations -
(reserve requirements + autonomous factors)
-50
O/N rate (RHS)
-100
Jun Jul Aug Sep Oct Nov Dec Jan
09
10
Source: BNP Paribas
Chart 2: Forward OIS-Refi Spreads
10
0
-10
-20
-30
-40
-50
-60
-70
1st
ECB
2nd
ECB
Source: BNP Paribas
3rd
ECB
4th
ECB
5th
ECB
6th
ECB
7th
ECB
8th
ECB
9th
ECB
0.70
0.65
0.60
0.55
0.50
0.45
0.40
0.35
0.30
0.25
10th
ECB
with 3mth LTROs. In other words, the ECB should
keep MROs attractive from a relative standpoint.
Fixed rate and full allotment conditions at the MRO
could therefore prevail beyond June. In the
meantime, the last 6m tender at the end of March
should benefit from the same conditions as the last
1y tender, i.e. full allotment and post determined rate.
However, as the tender expires in early October, the
probability of a rate above 1% is even lower than the
same probability for the last 1y tender. In such
conditions, excess liquidity could prevail beyond the
end of June, leading to lower Eonias in July and
August.
Strategy: The probability of excess liquidity
persisting beyond June is high enough to
recommend receiving the ECB’s May-Jul gap and to
pay the ECB’s Aug-Oct gap.
Percent
Patrick Jacq 29 January 2010
Market Mover, Non-Objective Research Section
34
www.GlobalMarkets.bnpparibas.com