Money Market Update: O Euribor, Where Art Thou?

Summary:

• Linear models suggest that in the next year and a half, we will see further gradual increases in euro money markets spreads as part of the normalization of the ECB balance sheet through bond roll offs;
• At the aggregate level, bank reserves will remain ample as a significant part of the roll offs are offset by other factors, including the ECB’s ongoing and massive operating losses. By end 2026 the ESTR-deposit rate spread will have increased by just 2bps compared to current settlements. Expect further marginal spread increases for overnight repo and 3-month Euribor;
• As a rule of thumb, for every 1bp increase in the repo spread, the Euribor 3-month spread with the 3-month ESTR swap rises 0.34bp. And for every 200 billion euros of QT (roughly four months’ worth of QT), the spread widens by a bp;
• Because the models are linear, they are inherently flawed. When bank reserves become scarce, spread increases become proportionally stronger. At the aggregate level, reserves will remain ample this year and the next. However, at the member state level, reserves are already low or will fall to low levels in the usual suspects. Later this year and next year, this could result in a faster than expected tightening of the unsecured market.

In case you missed it, my prior Update on the ECB's losses and the consquences for remuneration can be read here.