Economic and Financial Analysis

Rates

25 March 2021
Rates Spark: Third wave gloom
Article

Rates markets are seeing relief as concerns over the disruption caused by last
week's SLR decision are allayed, and with infection rates rising again in
Europe. Such relief could prove temporary, but the ECB will use every chance
to widen the gap versus the US. TLTRO money has just arrived in banks'
accounts - we look at the excess liquidty distribution.

Content
- Third wave gloom sees markets shrug off better data
- The seventh TLTRO.III has finally settled, pushing excess liquidity towards €4tn
- Today's events and market view

Third wave gloom sees markets shrug off better data

Over the course of yesterday 10Y US Treasury yields climbed steadily from below 1.6% to above
1.63%, a small pullback coming only after a decent 5Y auction eased fears over the actual
disruption caused by the Fed's SLR decision last week. EUR rates were able to decouple from the
uptrend, ending their day little changed versus the open at near -0.36% in 10Y. The spread
versus UST rewidened to near 200bp again.
There was some volatility and push higher in yields on the  back of much better than
anticipated PMI readings. But the data for the flash survey was largely collected ahead of the
recent lockdown extensions which risk further delaying the economic rebound. The positive PMIs
were eventually outweighed by concerns over still rising infection rates. Of course, the ECB
buying more via the pandemaic emergency programme (PEPP) in the background should have
helped.

The seventh TLTRO.III has finally settled, pushing excess liquidity towards
€4tn
Yesterday saw the settlement of the ECB's latest targeted longer-term refinancing operation,
the seventh TLTRO.III tranche. €331bn arrived in banks’ accounts and added to overall excess
reserves in the banking system, pushing these closer to €4tn. The TLTRO should further reduce
banks’ financing needs in other (short term) markets. In the past this substitution has been
instrumental in the decline of Euribor fixings in our view and a revisit of fixing lows would not
surprise against that backdrop. 

Excess reserves will continue to grow as more than €900bn remains to be spent of the ECB's
PEPP envelope in the coming three months at an accelerated rate of €60-100bn per month. This
comes on top of regular asset purchases of €20bn per month and the three more TLTRO
tranches still scheduled. Currently excess reserves incur a penalty of -0.5% that the ECB charges
for any reserves that exceed a bank’s minimum reserve requirement plus an allowance that
currently amounts to 6 times the minimum requirement. The allowance had been introduced
by the ECB in 2019 to lessen the burden of excess liqudity on banks, and one might think raising
the multiplier above 6 is overdue.

The TLTRO subsidy likely overcompensates for the cost of excess reserves

Source: ECB, ING

At this junction one should note that the TLTROs are provided to banks at a subsidy rate of as
low as -1%, provided that certain lending benchmarks are met. Currently the subsidy provided
via the TLTROs on aggregate should outweigh the penalty incurred on banks’ excess reserves. 
The ECB provides some country-level data for the distribution of excess liquidity including those 
amounts incurring the penalty. We can set that against the distribution of the longer term
operations - at the moment not including the latest tranche.
By the end of January – the latest available data point - Germany was saddled with the largest
amount of excess reserves, €601bn incurring the -0.5% penalty rate. At the same time German
banks also had more than €340bn in LTROs outstanding, most of it in TLTROs which can “earn”
them a rate of up to 1%, thus likely compensating for the cost of excess reserves. However, the
setup is particularly beneficial for Italian and Spanish banks with low excess reserves but high
TLTRO participation. Overall we conclude that increasing the tiering multiplier is unlikely to be
the most pressing issue in the eyes of the ECB at the moment.
 Today's events and market view
The data calendar for today features US jobless claims data and final 4Q GDP figures.
What we will continue to see is a busy slate of Fed speakers including Williams, Clarida,
Bostic and Evans. We will also hear from the ECB with Lagarde, Weidmann and Villeroy
speaking during the day and Schnabel following early in the evening. While Fed
speakers are unlikely to venture far from the already well-known narrative, we think the
ECB will use every opportunity - via action or word - to drive a wedge between US
developments and the eurozone. Currently the 10Y UST-Bund spread has topped out at
200bp, but we think more widening should be achievable.
In supply only Italy is active in eurozone selling inflation linked bonds and its first “BTP
Short Term”, in total up to €5.25bn. The US will sell US$ 62bn in 7Y notes.

Benjamin Schroeder
Senior Rates Strategist
+31 20 563 8955
benjamin.schroder@ing.com

Antoine Bouvet
Senior Rates Strategist
+44 20 7767 6279
antoine.bouvet@ing.com

Padhraic Garvey, CFA

Regional Head of Research, Americas
1 646 424 7837
padhraic.garvey@ing.com
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