***WARNING*** Interbank rate geekiness ahead! ***WARNING***
There’s been loads of attention this week on the short-end of the Euro Over Night Index Average (Eonia), which is basically a measure of liquidity in the eurosystem. You can see from the above that it just reached its highest level since about June 2009.
Here’s Bank of America Merrill Lynch’s Ralf Preusser and Max Leung:
The market has focused on two main reasons for the sell-off in the front-end of the EUR curve: (1) Jean-Claude Trichet’s hawkish commentary at the January press conference; and (2) the shrinking ECB balance sheet, particularly following the reduced take-up at the main refinancing operation (MRO) on Tuesday. The former has led the sell-off in the forwards, the latter has driven spot Eonia to settle above 1% for the first time since June 2009. Clearly both factors are important drivers of the front-end, but we would argue that the main surprise to market expectations may come from changing bank behavior in their liquidity management.
To understand what they mean, you have to look at what banks normally do.
And they’ve tended to front-load their current account holdings at the beginning of each reserve maintenance period to make sure that they have enough stuff to meet their reserve requirements. Over the course of the period, they run down their current account holdings, which tends to increase available liquidity in Europe. So you’d typically see Eonia start high and then decline over the reserve period.
What we’ve seen over the course of January is the exact opposite.
Banks’ current account holdings have been below their reserve requirements during this particular maintenance period, which runs from January 19 to February 8. Are we looking at a permanent change in the way eurozone banks behave?
Here’s some more from Preusser and Leung:
If the change is due to technical reasons, it will likely be temporary and we can expect the usual behavior to resume in the next RMP. Technically, this RMP is unique, in that it began in the third week of the month (on 19 January), a week later than a normal RMP. As a result, the 23rd calendar day of the month falls in the first week of this RMP, around which day the net autonomous factors of the banking system tend to increase because of seasonality. As banks chose only to maintain rather than to increase their ECB borrowings in that week’s tenders, some of them may have been caught short in cash and were then forced to draw on funds from their current accounts. This shortage of funds could also explain why Eonia volumes jumped on 21 January to the highest since September 2008 as banks borrowed in the market to meet the higher liquidity needs.
If the change is due to structural reasons such as the change in the ECB’s collateral haircuts, reflecting a shortage of collateral for some banks, then Eonia may continue to trade higher throughout the next RMP. It is very unlikely that the banking system will experience a collateral shortage on an aggregate level, so Eonia would only trade higher until collateral-rich banks adjust to the lower liquidity withdrawal from collateral-constrained banks.
This implies that we need to wait until the beginning of the next RMP to see whether banks’ reserve requirement management in January was driven by technical reasons or if there are more fundamental drivers distorting the Eonia market at the moment.
Even more to watch.
Related link:
The ECB exit hurts – hurts like negative €12.6bn - FT Alphaville