* ECB's "accommodative" stance creates one-way bet on rates
* LTRO repayments, high or low, seen flattening Eonia curve
* Trade already crowded, leaving slim gains for latecomers
By William James
LONDON, Feb 19 European Central Bank president
Mario Draghi has created a win-win situation for traders in the
run-up to Friday's announcement on early repayments of banking
sector loans, with short-term rates expected to go anywhere but
Traders are banking on the euro zone money market curve
flattening over the coming weeks, unwinding a rise in
longer-term borrowing costs that has effectively tightened
monetary conditions over the last month.
Larger-than-expected early repayments of emergency banking
sector loans in January caused money market rates to rise,
pushing up the wholesale cost of money that filters through the
financial system and drawing the attention of the ECB.
But, that reaction has since moderated and even a
larger-than-expected second repayment would be unlikely to
prompt another rise because markets believe this would increase
the chances of the ECB cutting interest rates to keep policy
Lower-than-forecast repayments, or any signal from the ECB
on cutting rates could even drive rates lower, market
"You could call it a Draghi 'put'. He suggested at the last
press conference that the ECB may act if it doesn't like what it
sees," said Elwin de Groot, strategist at Rabobank in Utrecht.
"So, if there's too strong a reaction from the market(to the
repayment) they may take new measures, and the first best option
is maybe a cut in the refinancing rate."
The faster the surplus of liquidity in the banking sector
shrinks, the more the money market curve steepens as traders
bring forward expectations of when increased competition for
scarce cash starts to push rates up.
A Reuters poll on Monday showed banks are expected repay 130
billion euros of the 530 billion euros they borrowed a year ago,
when the ECB flooded the banking sector with cash to prevent
funding seizing up completely.
That amount is slightly less than the 137 billion euros
which was repaid in January when the first of the two three-year
lending operations became eligible for early repayment.
"Last time I was expecting more people to bet on higher
rates, but Draghi hasn't helped," a trader said, adding that he
was expecting a flatter money market curve this time round.
A figure in line with polls would support Draghi's
assertion, made at the bank's monthly press conference, that
excess liquidity would stay well above 200 billion euros -- the
level below which overnight rate are widely expected to start
rising. Reuters data shows the surplus stands at 500 billion
However, the "one-way" nature of bets on the direction of
the money market has already driven the curve flatter, leaving
those late to the party targeting only small gains.
"On the Eonia forward curve we still favour a possible
flattening. But, at these level there is only limited room for
further flattening," said ING strategist Alessandro Giansanti,
highlighting the Eonia forward contract that shows rates are
expected to be 21 basis points in February 2014.
"This is about 9 basis points off the highs. . 21 basis
points is pricing in excess liquidity (by Feb 2014) of 250
billion -- a level that probably we will get close to."
The gap between the one-month Eonia rate and the
two-year rate, both of which measure expectations of
the average overnight borrowing cost over the life of the
contract, has narrowed to 17 bps from a peak of 31 bps.
"We have already seen quite a correction in the curve... so
you might say the market is now reasonably priced. Perhaps there
are no big opportunities anymore, but if there are any we should
see more flattening," Rabobank's De Groot said.