Sentiment Shifting At The ECB
Written by A Forex View From Afar on Sunday, December 14, 2008The money markets in the Euro-area are currently experiencing a rather unusual event. The EONIA rate or the reference rate in the Euro-area is trading above the ECB’s target of 2.75% for the first time in the last few months.
Furthermore, the EONIA swap contracts, which practically gauge the prime bank’s sentiment over future interest rates, show a humped yield curve, indicating that the market is shifting its view. This comes after the EONIA swap market had a reverse yield curve, which usually indicates that the market expects that the ECB will carry on reducing interest rates.
The most important thing that happens these days in the EONIA swap market is that the spreads between the short-term and the long-term maturity dates are converging, confirming that the market expects the ECB to alter its rate cut cycle. As seen in the attached chart, the spread between the 2 year maturity date and the 1 week has almost approached zero, while it was trading at -0.8 a few weeks ago. The big swing in the European money-markets happened around the same time, subsequent to Mr. Trichet’s speech held one week ago.
At the same time, it looks like the currency market has had a similar shift. On the day Mr. Trichet held the usual press conference, the euro managed to find a bottom against the dollar and then gained approximately 600 pips, to reach the highest value for the last two months on Thursday.
The change in sentiment regarding the future ECB interest rate can be a plausible cause for the strong gains the euro posted lately. On Thursday, for example, the euro advanced a strong number of pips, despite U.S. futures running into the red. On negative equity markets, the low yielding currencies, like the dollar and the yen strengthen, however, this was not the case for the dollar. Today, it was the first time in the last few months when the euro advanced on negative U.S. futures. Also, the euro might have been helped by the extremely low yields on the U.S. Treasury notes.
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