- Excess liquidity in the eurozone rises due to the end of the ECB’s absorption tender …
- … putting downward pressure on short-term interest rates
- Meanwhile, ECB tries to keep expectations of QE alive
Excess liquidity in the eurozone financial system rises ….
The amount of excess liquidity in the eurozone system jumped higher yesterday, when the ECB suspended its weekly absorption tender (i.e. the sterilization of its SMP programme), as was announced by the central bank on 5 June. At its last absorption tender of last week the central bank had mopped up EUR 108bn of liquidity. However, the suspension of the tender had a more limited impact on excess liquidity, largely because banks reduced borrowing via the ECB’s main refinancing operations by around EUR 39bn. Moreover, excess liquidity was reduced by a rise in autonomous factors (of around EUR 28bn), which are out of the ECB’s control and often are related to tax receipts by national governments put on deposit at national central banks. As a result, excess liquidity rose by merely EUR 39bn from EUR 122bn to EUR 160.8bn. We expect the eurozone’s liquidity pool to remain large during the rest of this year, as autonomous factors should have a less negative impact, but also because liquidity will be boosted by the ECB’s new TLTROs in September and December.
…. putting downward pressure on money-market rates
Although, the rise in excess liquidity was smaller than was to be expected based on the suspension of the absorption tender alone, it had a downward impact on short-term interest rates, with the EONIA fixing falling to 0.015% on Wednesday from 0.03% on Tuesday. Meanwhile, implied future money-market rates also moved lower. We think that this trend is not over yet. As excess liquidity is expected to remain plentiful, the EONIA should end up at zero or slightly negative rates, as it will be pushed in the direction of the deposit rate of -0.1%. This should pull the 3m Euribor rate further down, to around 0.1% three months from now.
ECB tries to keep expectations of QE alive
Meanwhile, during a speech in Athens, ECB Vice President Victor Constancio tried to keep market expectations of a possible QE programme by the ECB alive. He said that in case “the risks of a protracted period of low inflation materialize” the ECB’s policy response would “involve a broad-based asset-purchase programme”. However, earlier statements by ECB President Mario Draghi and other ECB officials have clearly signalled that the ECB appears uncomfortable in going down that road as long as the economic recovery remains broadly on track. So, a broad-based QE programme is not part of our base scenario. However, we think bond markets will continue to price in some possibility of QE, keeping government bond yields low over the next few months.
Dovish Fed trade continued to play out in markets
Investors interpreted the Fed decision, its statement and the Q&A session as re-enforcing the view that policy rates would not be going up any time soon. As such, they were perceived as having a dovish tilt. This had ramifications for financial markets. On the one hand, stocks continued to rally on the prospect that the Fed will leave the punchbowl in place. Moreover, emerging market currencies and high yielding currencies performed well. On the other hand, the US dollar and US Treasury yields edged lower. All this is rather predictable, but what we find most noteworthy is the market’s view about the inflation outlook in the US. Since the start of this week, 5y inflation expectations have risen. The recent higher than expected US inflation numbers and higher oil prices are the key factors behind this trend. However, the Fed’s dovish remarks of course did nothing to change the market perception on inflation. Indeed, inflation expectations continued to rise on Thursday. The current situation in Iraq and higher inflation expectations have pushed gold prices higher. If this environment continues in the near term, it is likely that gold prices will continue to move higher for now.