Did you notice the, erm, fireworks in the September Schatz last week?
This particular futures contract in German short-term debt reached an all-time high on Friday.
And those unlucky enough to (still) be short-the-Schatz can blame this man — Bundesbank head and European Central Bank governing council member Axel Weber — and his Thursday interview with Bloomberg News.
In it, Weber effectively pre-empted the upcoming September 2 ECB meeting, suggesting the central bank is unlikely to change its current (fixed rate full allotment) liquidity set-up until the start of 2011. This is rather later than the market was expecting, which, added with some lacklustre economic data points, meant Friday ended up being one of those increasingly common ‘risk-off days.’
Result: Schatz went up, along with Bund prices and US Treasuries, while money market rates like Eonia moved sharply lower. A comment from IFR Markets’ Divyang Shah sums up the Schatz-short pain:
Is this the way for a front-runner for the ECB President job to behave? We had all been led to believe that the ECB does not pre-commit and that we would have to wait until September in order to find out what the ECB intends to do with their liquidity operations beyond Q3. Along comes Weber and throws the whole notion of pre-commitment out of the window by saying that the current allotment mode will be maintained until after year-end and the normalization procedure will be a focus for Q1. This was enough to send Sept Schatz screaming to a new contract high and the forward EONIA curve to move sharply lower. The 2-year Schatz yield is likely to find it difficult to get below 0.57% unless the ECB actually shifts toward ending the exit completely which seems unlikely.
Weber’s comments were enough to take us out of our short Schatz position but we are happy to maintain the pay 12×24 EONIA position which has moved back to our entry level. The risk now is that either Weber’s views are confirmed or the ECB will embark on an earlier exit than that which has been communicated by Weber thus risk/reward still favours holding the trade. Added support comes from the fact that there are still some EUR 205bn in 6-month and 1-year operations maturing this year which should leave a lower level of excess liquidity in the money markets. Our own analysis shows that once this excess liquidity gets to 50/60bn (currently just below 100bn) then this will have a more significant impact on EONIA.
In other words, even if the ECB commits to maintaining its full allotment policy, that doesn’t necessarily mean the eurozone will still be swimming in excess liquidity.
For instance, €225bn of ECB funding is due to expire on September 30. Meanwhile, the September three-month Long-Term Refinancing Operation (LTRO) will be allotted on the 29th, and its take-up will help dictate future levels of liquidity.
According to RBS, current daily excess liquidity in the system is around €100bn — about the level needed for Eonia to average between 40-45 basis points, or in line with its current rate.
Barclays Capital, meanwhile, also think excess liquidity is currently about €100bn, but they reckon that’s likely to decline by about €10bn to 15bn on ‘autonomous factors.’
Related links:
Weber watching - Money Supply
Losing ECB liquidity = two small rate hikes, says Citi - FT Alphaville
For the ECB – ‘The door is locked, there is no exit…’ - FT Alphaville