The cost of short-term interbank money fell to record lows again Wednesday, with market participants already turning their focus to the European Central Bank's tender of one-year funds at the end of the month.
Financial institutions' overnight deposits at the ECB tumbled, data on Wednesday showed, as the central bank drained almost 200 billion euros from the banking system on the last day of its reserve maintenance period. But the amount of liquidity sloshing around the short end of the system is more than enough to keep the nominal cost of interbank lending down, and the relative cost of those funds to expected official policy rates.
And with the ECB's tender of unlimited one-year funds at 1 percent on September 30 already looming large interbank rates and spreads could head even lower, although whether that translates into increased lending to businesses and households remains to be seen.
"The sheer weight of money will bring rates down, and while there's downward pressure there will continue to be a time value for money so you will continue to see a positive curve," said Chris Oulton, chief executive officer of Prime Rate Capital Management, a London-based money market fund with over $1 billion of funds under management. Upward sloping curves weren't confined to money markets: the 2/10-year eurozone government bond curve on Wednesday hit its steepest ever level at 227 basis points, Reuters charts showed.
The cost of short-term euro, dollar and sterling funds remained well and truly anchored on Wednesday. London interbank offered rates for three-month dollar funds was fixed below 0.30 percent for the first time ever by the British Bankers Association on Wednesday. The equivalent euro and sterling rates were also set at record lows below 0.75 percent and 0.65 percent respectively. The overnight euro Libor rate fell back to 0.27 percent from 0.48 percent Tuesday, as the previous day's spike was in response to the ECB's fine-tuning operation to drain funds from the money market at the end of the reserve maintenance period.
The Libor/OIS spreads across the three main currencies, a measure of market stress and credit risk which measures the difference between interbank rates and expected policy rates and take into account, also tightened again.
Rates strategists at Goldman Sachs believe there's room for further compression too. "With policy rates in `core G10' still anchored at very low levels for some time, several `spread markets', particularly in Euroland and the US, have still more room to compress," they said in a note on Wednesday. They say receiving forward US overnight index swap rates is a particularly attractive carry trade, because the front-end of the US rates curve is unlikely to sell off sharply as it did the same way it did in June/July. The ECB allotted only 3.16 billion euros at its three-month tender and 3.7 billion euros at its six-month tender on Wednesday. Both allotments were at a fixed 1 percent.
Some analysts say banks might be holding off from taking up funds at these shorter-term tenders, and keeping their collateral to exchange for one-year funds. In late June, at the first ever tender of one-year funds, the ECB injected almost half a trillion euros into the money market. Demand at the second one later this month will likely be lower, although it's hard to put a number on it.