Some money market players are betting the European Central Bank will offer banks new long-term loans (LTROs) to counter upward pressure on short-term interest rates from the Federal Reserve's stimulus reduction.
The U.S. central bank is expected to trim its $85 billion-a-month asset purchase program at its Sept 17-18 meeting, in a move seen as the beginning of the end for ultra-loose monetary policy employed by major central banks around the world.
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Investors are generally expecting those policies, put in place to help economies withstand the fallout from the global financial and eurozone crises, to be phased out now the economic outlook has improved.
But several banks including Barclays Capital and Societe Generale are recommending investors go against the view reflected in current money market rates that the ECB will not ease monetary policy any further.
"A lot of people have thrown in the towel on ECB easing, but they may have thrown it too early," said Vincent Chaigneau, head of fixed income and forex strategy at Societe Generale.
If the Fed starts trimming bond purchases, short-term interest rates could return to this year's highs in coming weeks to reflect tighter global liquidity conditions.
This would take some euro zone money market rates of two-year maturities or shorter above the ECB's 0.50 percent refinancing rate - a point at which investors begin to price in the probability of an ECB rate rise. This would be a trading opportunity for those who think the ECB could even ease policy.
After the last ECB meeting, President Mario Draghi said the economic recovery was still very "green" and the recent peaks in market rates were "unwarranted". He also warned the ECB would be "particularly attentive" to liquidity conditions.
The ECB has promised to keep rates low for the foreseeable future or even cut them further. But with the economic outlook improving, analysts said a cut was unlikely given the bank's reluctance to make the move when the economy looked worse.
The potentially more efficient step the ECB could take to keep a lid on rates is to inject cash into the banking system, where excess liquidity - the cash banks hold beyond what they need - is shrinking as banks repay the three-year loans they took at the height of the debt crisis.
"If we do start seeing the beginning of the Fed tapering cycle kicking in and the excess liquidity falling further then I would expect some kind of new LTROs at some point towards the end of the year," ICAP strategist Philip Tyson said.
Another LTRO, however, would have to be more attractive than those being repaid for banks to consider it.
Barclays strategists, who also expect a new LTRO by the end of 2013 if money market rates keep rising, said it could be fixed to the 0.5 percent refinancing rate to make it attractive. Collateral requirements might also be relaxed, they said.
Analysts say by fixing the rate of the LTRO, the ECB would achieve two things: it would inject cash into the system and it would enhance the credibility of its interest rate guidance.
"(A fixed rate LTRO) would be sending a message because it really ties them down," RBS strategist Harvinder Sian said.
Excess liquidity last stood at 243 billion euros, slightly more than a quarter of what it was early in 2012 after banks took more than 1 trillion euros from two LTROs. Eonia rates have risen historically when it falls below 200 billion euros.
Banks commonly express their views on ECB policy through one-year, one-year (1y1y) forward Eonia rates, which reflect where the one-year Eonia is expected to trade in one year's time - a period widely thought to encompass the time span of the ECB's forward guidance on interest rates.
The rate was last just above 0.40 percent, down from last week's 2013 highs of 0.56 percent - a level which suggests markets expect a rate hike, according to JPMorgan's head of asset allocation Nikolaos Panigirtzoglou.
Some poor U.S. data and uncertainty about who would succeed Fed Chairman Ben Bernanke sent the rate lower in recent days, but Panigirtzoglou expected it to resume rising after the Fed meeting.
"Is pricing in one rate hike too much for the ECB? If the ECB was uncomfortable, they would likely have done something about it already," he said. "Pricing two rate hikes would probably make them act, so maybe 65-70 basis points is a more likely (1y1y Eonia) level at which the ECB responds."
At those levels, he would recommend betting the 1y1y Eonia rate would fall. Societe Generale and Barclays already do.
The 1y1y Eonia traded as low as 0.07 percent in May, before the Fed first signalled it would reduce its stimulus.
(Editing by Nigel Stephenson and Anna Willard)