Hi! Since the ECB introduced 12M tenders the EONIA and Euribor curves have bull flattened. With the money market curve essentially flat and the deposit-refi rate corridor narrowed the incentives for lending in the interbank market has decreased since virtually no term premia can be earned from moving out on the curve. As a result liquidity is flowing back into the overnight market. How does that affect EONIA rates? I have read that this depresses EONIA but what is the rationale for that? Since any money placed on a term deposit in a bank must be lent out to either another bank or to the ECB on an overnight basis the amount of money placed in the overnight market (including the deposit facility at the ECB) is constant for a given money supply. Right..? Hence if banks roll all the money in the EONIA market directly or if they first lend it on term and then the money tickles down to the EONIA market would not make a difference right? Thus, the fact that the curve is flat should not put any downward pressure on EONIA. A narrowing of the corridor could, however, have a downward pressure since the penalty for not participating in the EONIA market but rather placing the cash at the ECB directly has decreased. But that is a separate issue from the slope of the money market curve. EONIA has fallen substantially though since the 12M tenders were announced so I guess there is something I do not understand here. I would be most grateful if anyone could help me understand why a flatter curve and front-loaded liquidity would depress EONIA. Thanks a lot for any comments!

The dynamic is somewhat complicated, but I will try to respond as best I can...

Martinghoul if you would like to respond I would be most grateful. Thanks a lot!

Sorry, FM, I got side-tracked and forgot... Lemme put together a suitable bit of blurbage, based on my understanding of things. I'll be back!

FM, to me the mechanism is quite a lot simpler and doesn't really involve anything too technical...Essentially, once a bank has guaranteed 12m funding from the ECB (with subbable collateral) for all of their dodgy assets, it has freed up its balance sheet greatly. That should allow it to be more aggressive in both the O/N and term interbank mkt, whether it's EONIA or unsecured. Once that happens to a bunch of banks and margins again become the focus, competitive interbank lending should resume, which should exert downward pressure on the fixings.To me it's that simple. Let me know what you think...

Thanks alot for your answer Martinghoul! Always appreciated. However, if it is true that the 12M tender frees up balance sheet (which I think is true) would that not push EONIA upwards (ie towards refi) since banks can as you said be more aggressive (ie lend more in the interbank market instead of placing at the ECB) and EONIA was too low? I agree that balace sheet improvement would put downward pressure on term fixings but is the same for EONIA since the low level of that rate was interpreted as a sign of risk aversion?When EONIA started to rise above refi it was seen as a positive sign (eg ECBs Papademous made a speech a few weeks ago were he referred to the recent rise in EONIA as a positive yet fragile development)...

FM, there are some interesting things happening in EONIAland post the 1y LTRO...

I have just read this, maybe it is of some interest.

Last week the ECB allocated €442bio of collateralised funding to 1,121 banks via its 1 year LTRO. Banks could bid for an unlimited amount of cash at a fixed rate of 1%. The effect of this has been a sharp drop in rates at the front end of Europe as the Eurosystem is now awash with cash. The overnight rate fixed at 0.388% on Friday and the 1 week Euribor dropped 24bps on Thursday. expect Euribor settings to grind lower over the coming weeks and see good value in 1 month Eonia swaps at 0.55%. 2yr yields have dropped steadily over the last 2 weeks following the sharp rise after the previous ECB meeting. The ECB meets again this Thursday and expect them to repeat the ‘rates are appropriate’ line again.

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On a side note does anyone have any comments about lasts weeks 1D draining by the ECB (some 300bn was drained). Why did the ECB drain for 1d? I mean that does not seem to matter much to the market or? Did they somehow want to test how the market would react or how can we understand this?

QuoteOriginally posted by: freddiemacOn a side note does anyone have any comments about lasts weeks 1D draining by the ECB (some 300bn was drained). Why did the ECB drain for 1d? I mean that does not seem to matter much to the market or? Did they somehow want to test how the market would react or how can we understand this?Isn't this sort of their plan? Lend long (specifically, to cover the year end) and drain in short-dates?

My understanding is that the ECB have not drained the market of late. They have publicly discussed draining the market and doing so on a term basis but they have refrained from doing so. However, last week when EONIA was at all time lows they drained for one day. (The draining differs from the deposit facility since depo is 25bp while draining is competitive bids (i think the average was around 40bp in last weeks draining ie substantially higher than the depo rate although lower than refi). It just seems like a random event to me, like somehow they would like to see how much interest the draining operation would attract or something.