Something strange has happened during the last few days. Eurepo rates, especially for short maturities have increased substantially, while Eonia swaps (a derivative used to transform overnight interbank lending at the EONIA rate to a fixed rate) have decreased. This is quite evident if one compares the one week Eonia swap and eurepo rates:

The following graph outlines the spread between the Eonia swap and the Eurepo rate for maturities of 1 week, 1/3/6/12 months. I ‘ve selected these maturities because they match those of ECB’s refinancing operations (which means that they can probably react to ECB actions):

The following are evident from the chart:

  1. Spreads for short maturities decreased at the start of 2012 (reversing an ‘invertion’ on the spread curve).
  2. After the second LTRO all maturities moved close to each other with the spread stabilizing around 20bp.
  3. Around the end of April long tenor spreads decreased, with 6/12 month spreads dropping to 15bp while the 3-month spread remained in the middle, around 17bp. Shorter tenors (1 week, 1 month) did not react and remained around 20bp.
  4. During the last few days all spreads have tightened, with short tenors dropping to 17bp, while longer maturites dropped significantly to 10bp (with 3 and 6-month spreads moving together).

The next graph shows the spread between different maturities, mainly an Eonia swap of 3 and 12 months over the 1 week eurepo. It’s obvious from the above graph that 3 distinct spreads exist, the 1 week/1 month, the 3 month and the 3/12 month.

The spreads moved in parallel at the start 2012, dropping to 10bp (end of January) and returning to 20bp after the second 3Y-LTRO. They started dropping and diverging around the end of April and reached 15bp for the 3-month spread and 10bp for the 12-month spread. Lately, they have both dropped significantly to 8bp for the 3-month spread and 5bp for the 12-month spread.

The above observations are rather interesting. Secured lending rates are increasing while unsecured rates do the opposite. Long-term unsecured fixed rates are quite cheap while (very) short-term secured rates are stressed. The spread between borrowing unsecured for a year and lending secured for a week has dropped to only a few basis points.

As long as present developments persist, a bank with excess liquidity should short a long-term interest rate swap and offer funds overnight in the repo market. The swap will lock in a high fixed rate (and provide collateral as the NPV increases) while the repo rate will increase on a daily basis. Since April such a position is quite profitable.

What is quite certain though is that both the Eurepo and Eonia Swap curve are heavily inverted (around the 3-month mark) which isn’t a positive sign: suggests that the above behavior might be an indication of market segmentation. Only a few banks actually have access to the unsecured interbank market and can provide quotes for eonia swaps. Consequently, the unsecured market might be projecting a rate cut by the ECB in the near future (which if coupled with a rate cut or zeroing of the deposit rate will drop already low EONIA rates close to zero) and quote long-term rates accordingly, while the secured market is probably facing elevated short-term credit risks. Actual lending might only be available for very short tenors with increased rates (with only quotes available for long tenors without any available funds except for low risk counterparties) pushing the corresponding curves to a strong inverted shape.