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Global 2 July 2012 Fixed Income Special Report Money Market Monitor Deutsche Bank AG/London All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 072/04/2012. Strategy Update Table of Contents EUR .................................................................. Page 02 GBP .................................................................. Page 06 USD .................................................................. Page 09 Research Team Soniya Sadeesh, CFA European Rates Research (+44) 0 207 547 3091 soniya.sadeesh@db.com Fi xe d In co m e G lo b al M ar ke ts R es ea rc h Fi xe d In co m e R el at iv e V al u e „ ECB dates are pricing a cut to the deposit rate at the July meeting, with 1Y Eonia also trading below the current 25bp floor. We look at the implications for Eonia under different rate cut scenarios, which highlights the pass- through to Eonia is extremely limited if only the refi rate is cut „ As a rate cut is expected to impact Euribor more relative to Eonia, the Euribor/OIS bases are at the tightest levels in a year. Cutting only the refi but not the deposit rate could further tighten the bases, as Eonia sells off, though given current levels the move might be limited „ In the UK, the Governor announced the activation of the Extended Term Collateral Repo in his Mansion House speech, alongside a new “funding for lending” scheme „ The front end has performed strongly since the announcement, due in part to a compression in the Libor/OIS basis, which was elevated on a cross country basis. Part of the move however was also due to increased pricing of a rate cut „ Currently the market is pricing around 5% chance of a cut in the next meeting which increases to around 35% priced by the December meeting. This has alleviated somewhat post minutes, and TSC testimonies, which suggested that QE is still currently the preferred option for further policy easing. We favour holding short sterling steepeners, or paying 1Y1Y SONIA In addition, 3M6M wideners appear attractive, given the extent of the tightening seen post announcements „ US prime money market funds continue to hold more than 10% of assets in unsecured European financial institution paper, providing a lifeline of roughly $160bn that could be pulled if conditions worsen in the region „ Over the past three months, the sector pulled an estimated $52bn in funding via holdings of CDs and finance company commercial paper from Europe and replaced the bulk of that amount with CDs and commercial paper in Canada and Japan, according to our review of the largest prime money fund portfolios „ Pure risk aversion may explain only a portion of the recent changes in regional exposure of money funds to Europe. First, European banks are deleveraging and derisking and may be selling dollar-denominated assets, reducing the demand for dollar funding. Second, to comply with U.S. regulations limiting exposure to banks with second-tier short-term credit ratings, money funds may have been proactively reducing exposure to paper from global banks that had been placed under watch for a downgrade by Moody’s. Third, finance companies and banks from Canada and Japan may be offering more attractive rates to money funds 2 July 2012 Fixed Income Special Report Money Market Monitor EUR „ ECB dates are pricing a cut to the deposit rate at this week’s meeting, with 1Y Eonia also trading below the current 25bp floor. While the rate paid on OMOs are linked the to the refi rate, the pass- through to Eonia is extremely limited if only the refi rate is cut (see below for table) „ Euribor/OIS bases are at the tightest levels in a year, as a rate cut is expected to have a larger influence on Euribors relative to Eonia. Cutting only the Refi but not the deposit rate could further tighten the bases, as Eonia sells off, though given current levels the move might be limited „ The line item in the weekly ECB financial statement incorporating ELA has been fluctuating in recent weeks. This could be attributed to shifting of OMO exposure (in the June ECB press conference, Draghi noted that “…Greek banks which were lacking capital have been recapitalized and therefore been readmitted as counterparty to monetary policy operations”). It remains to be seen whether the continued rise in MRO since is entirely due to this „ The ECB announced an expansion of the eligible collateral pool on 22 June, which primarily related to lower rated ABS and RMBS Potential impact of a rate cut on Eonia EONIA 0.331 July ECB date 0.246 Current Scenarios Refi Rate, % 1 0.75 0.75 0.75 Deposit Rate, % 0.25 0 0.125 0.25 Corridor , bp 150 150 125 100 Implied Eonia 0.081 0.19 0.30 Source: Deutsche Bank, Bloomberg Financial LP, Note: Assumes EONIA is driven by the relative position within the corridor and that this is maintained in the event of a rate move. Assumes no liquidity impact eg of further LTROs Euribor Strip, Level and Spreads Current % 1M Change bp Current bp 1M Change bp U2 0.49 -6 U2/U3 3 0 Z2 0.47 -8 Z2/Z3 12 4 H3 0.47 -7 H3/H4 17 5 M3 0.50 -6 M3/M4 22 6 U3 0.52 -6 U3/U4 27 6 Z3 0.59 -3 Z3/Z4 31 6 H4 0.64 -2 H4/H5 36 8 M4 0.72 -1 M4/M5 41 10 U4 0.80 0 U4/U5 45 12 Z4 0.90 2 Z4/Z5 48 13 H5 1.00 6 H5/H6 52 13 M5 1.12 9 M5/M6 54 13 U5 1.25 13 U5/U6 54 13 Z5 1.38 15 Z5/Z6 55 13 H6 1.52 19 H6/H7 53 13 Source: Deutsche Bank, Bloomberg Finance LP Swaps, Level % 3M 6M 9M 1Y 18M 2Y Spot -1.3 -3.6 -4.2 -4.3 -31.0 -1.2 3M -5.8 -5.7 -5.3 -4.5 -27.6 -1.0 6M -5.5 -5.1 -4.1 -2.7 -24.9 1.0 9M -4.7 -3.4 -1.8 -0.6 -22.0 3.4 1Y -2.1 -0.3 0.8 1.8 -18.9 5.3 18M 3.1 3.9 5.2 6.9 -13.5 11.0 2Y 7.8 8.0 9.4 9.9 13.9 16.9 Source: Deutsche Bank Swaps, 1M Change bp 3M 6M 9M 1Y 18M 2Y Spot 0.67 0.59 0.55 0.54 0.55 0.85 3M 0.51 0.50 0.50 0.51 0.54 0.83 6M 0.49 0.50 0.51 0.53 0.58 0.87 9M 0.51 0.52 0.54 0.57 0.63 0.93 1Y 0.54 0.56 0.59 0.62 0.69 0.99 18M 0.64 0.67 0.71 0.76 0.85 1.17 2Y 0.79 1.05 1.03 1.15 1.26 1.37 Source: Deutsche Bank 2 July 2012 Fixed Income Special Report Deutsche Bank AG/London Page 3 3M Carry and Rolldown bp 3M 6M 9M 12M 18M 24M Spot 0.0 -16.1 -8.9 -5.4 -1.6 0.5 3m -16.1 -8.9 -5.4 -3.2 -0.5 1.5 6m -1.8 0.0 1.1 2.0 3.3 4.9 9m 1.7 2.5 3.3 3.7 5.0 6.2 12m 3.4 4.0 4.4 5.0 6.5 7.3 24m 8.5 9.5 9.1 9.8 10.7 11.1 36m 12.8 12.0 11.6 11.9 12.7 11.8 Source: Deutsche Bank Outstanding OMOs split by MRO vs LTRO (EUR bn) 0 200 400 600 800 1000 1200 1400 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Mar-11 Dec-11 LTRO MRO OMO outstanding , EUR bn Source: Deutsche Bank, National Central Banks, ,Ireland usage does not include ELA Other claims on banks / ELA 0 50 100 150 200 250 300 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Other claims on banks The ECB started reporting ELA under one line item - other claims on EA credit institutions denominated in euro - from the end of April Source: Deutsche Bank, ECB, Standing Facility Usage (EUR bn) -35 -30 -25 -20 -15 -10 -5 0 0 100 200 300 400 500 600 700 800 900 Jan-11 Jul-11 Jan-12 Deposit Facility Marginal Lending Facility (rhs) Source: Deutsche Bank, Bloomberg Finance LP , MLF usage inverted Excess Liquidity (EUR bn) -200 0 200 400 600 800 1000 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Excess Liquidity Source: Deutsche Bank, Defined as OMO Usage + Covered bond Purchases net of current account holdings and autonomous factors Eonia volatility intra-maintenance period 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 01 -0 9 06 -0 9 11 -0 9 04 -1 0 09 -1 0 02 -1 1 07 -1 1 12 -1 1 05 -1 2 Standard Deviation Source: Deutsche Bank, Standard deviation of EONIA over maintenance periods 2 July 2012 Fixed Income Special Report Page 4 Deutsche Bank AG/London EONIA pricing 0.20 0.25 0.30 Current % Deposit Rate Source: Deutsche Bank, Bloomberg Financial LP Forward Bases 0 10 20 30 40 1st 2nd 3rd 4th 5th 6th 7th 8th Current 1M Ago Source: Deutsche Bank, Bloomberg Finance LP Euribor-OIS basis current and relative to history 0 20 40 60 80 100 120 Spot 1 2 3 4 5 6 7 1Y Range Current 1Y Average Source: Deutsche Bank Euribor pace of declines -1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 3M 6M daily changes, 10d rolling average Source: Deutsche Bank, Bloomberg Finance LP Spot and 4th Contract Basis 0 20 40 60 80 100 120 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Spot Fwd (4th contract) Source: Deutsche Bank, Bloomberg Finance LP FX Basis (3M) -160 -140 -120 -100 -80 -60 -40 -20 0 20 GBP EUR 3M cross currency basis Source: Deutsche Bank, Bloomberg Finance LP 2 July 2012 Fixed Income Special Report Deutsche Bank AG/London Page 5 FX Basis out to 5Y -70 -65 -60 -55 -50 -45 -40 -35 -30 -25 -20 3m 1y 2y 3y 4y 5y Current 1W Ago 1M Ago Source: Deutsche Bank, Bloomberg Finance LP 3m-6m Basis 0 5 10 15 20 25 30 35 -1.6 -1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 1Y 2Y 3Y 4Y 5Y 6Y 10Y 12Y 15Y 1m change current (rhs) Source: Deutsche Bank, Bloomberg Finance LP Money Market Slope 0.0 0.5 1.0 1.5 2.0 2.5 3.0 -0.20 0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40 1.60 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 ER 2-6 Slope ER 4-8 Slope 1Y1Y (rhs) Source: Deutsche Bank, Bloomberg Finance LP Soniya Sadeesh (44) 207 547 3091 2 July 2012 Fixed Income Special Report Page 6 Deutsche Bank AG/London GBP „ The Governor announced the activation of the Extended Term Collateral Repo in his Mansion House speech, alongside a new “funding for lending” scheme. „ The Governor also warned that the need for QE was rising, a point highlighted by the June minutes which revealed a 5-4 split where the Governor was one of the minority voting for QE „ The discussion also considered other policy options including cutting Bank Rate or reducing the rate paid on reserves. The MPC concluded that cutting Base further “would not have any advantages over an expansion of the asset purchase programme”, while noting there were disadvantages to cutting the rate paid on reserves. This suggests that if rate cuts were to be discussed, the former would more likely be considered, though in our view it would require a further deterioration in conditions before this option is acted on „ The front end has performed strongly since the announcement, due in part a compression in the Libor/OIS basis, which was elevated on a cross country basis. Part of the move however was also due to increased pricing of a rate cut „ Currently the market is pricing around 5% chance of a cut in the next meeting which increases to around 35% priced by the December meeting. This has alleviated somewhat post minutes, and TSC testimonies. We favour holding short sterling steepeners, or paying 1Y1Y SONIA „ The ECTR is available to banks which can access the Discount Window and accepts the widest range of collateral eligible. It is a variable rate repo operation, where the minimum bid rate is currently set at Base+25bp. This should provide a liquidity backstop and reduce funding risks „ The first ECTR tender was held on 20th June, where the auction size was set at GBP 5bn. The full amount was allotted, with the clearing rate equal to the minimum bid rate, suggesting no strong need for additional liquidity „ Sterling Libor/OIS bases now appear more inline with cross market comparisons, and are also around the lows over a one year period „ The 3s6s basis also tightened markedly post the Mansion House speech. Given the extent of the move, holding wideners appears attractive Short Sterling: Level and Spreads Current % 1M Change bp Current bp 1M Change bp U2 0.76 -18 U2/U3 -9 -4 Z2 0.71 -22 Z2/Z3 -1 1 H3 0.67 -23 H3/H4 6 3 M3 0.66 -23 M3/M4 12 4 U3 0.67 -22 U3/U4 17 4 Z3 0.70 -21 Z3/Z4 22 4 H4 0.73 -20 H4/H5 27 5 M4 0.78 -19 M4/M5 32 7 U4 0.84 -18 U4/U5 37 10 Z4 0.92 -17 Z4/Z5 42 14 H5 1.00 -15 H5/H6 44 14 M5 1.10 -12 M5/M6 47 16 U5 1.21 -8 U5/U6 50 16 Z5 1.34 -3 Z5/Z6 48 12 H65 1.44 -1 H6/H7 48 -1 Source: Deutsche Bank, Bloomberg Finance LP BoE OIS Pricing Current Incremental change % Hike/Cut* Cumulative Changes % Hike/Cut* Jul-12 0.458 -0.11 0% -0.11 0% Aug-12 0.425 -3.25 -13% -3.36 -13% Sep-12 0.412 -1.3 -5% -4.66 -19% Oct-12 0.405 -0.7 -3% -5.36 -21% Nov-12 0.398 -0.7 -3% -6.06 -24% Dec-12 0.365 -3.32 -13% -9.38 -38% Jan-13 0.362 -0.28 -1% -9.66 -39% Feb-13 0.346 -1.57 -6% -11.23 -45% Mar-13 0.339 -0.75 -3% -11.98 -48% Apr-13 0.336 -0.3 -1% -12.28 -49% May-13 0.331 -0.45 -2% -12.73 -51% Jun 13 0.328 -0.38 -2% -13.11 -52% Jul 13 0.329 0.13 1% -12.98 -52% Source: Deutsche Bank , Bloomberg Finance LP, * Assuming 25bp rate change Swaps, Level % 3M 6M 9M 1Y 18M 2Y Spot 0.89 0.83 0.80 0.78 0.75 0.98 3M 0.77 0.75 0.74 0.73 0.73 0.93 6M 0.72 0.72 0.71 0.71 0.73 0.92 9M 0.71 0.71 0.71 0.72 0.74 0.94 1Y 0.70 0.71 0.72 0.73 0.76 0.97 18M 0.75 0.75 0.77 0.79 0.86 1.08 2Y 0.80 0.97 0.96 1.04 1.13 1.23 Source: Deutsche Bank 2 July 2012 Fixed Income Special Report Deutsche Bank AG/London Page 7 Swaps, 1M Change bp 3M 6M 9M 1Y 18M 2Y Spot -9.8 -13.7 -16.1 -17.1 -17.5 6.0 3M -17.4 -19.2 -19.4 -19.4 -45.2 -23.8 6M -21.1 -20.5 -20.1 -19.5 -42.7 -24.0 9M -19.7 -19.5 -18.8 -17.4 -40.7 -23.0 1Y -19.1 -18.3 -16.5 -15.9 -38.6 -21.5 18M -12.7 -13.3 -14.1 -14.5 -34.0 -15.6 2Y -15.4 -22.8 -19.4 -20.0 -14.4 -9.5 Source: Deutsche Bank 3M Carry and Rolldown bp 3M 6M 9M 12M 18M 24M Spot -12.0 -8.5 -6.2 -3.6 -2.1 3m -12.0 -8.5 -6.3 -4.9 -2.4 -1.2 6m -5.4 -3.4 -2.6 -1.5 -0.4 0.9 9m -1.2 -1.0 -0.2 0.7 1.3 2.6 12m -0.8 0.3 1.3 1.1 2.3 4.2 24m 4.9 5.0 6.0 7.3 8.3 9.2 36m 11.0 10.3 10.6 11.1 11.5 11.6 Source: Deutsche Bank BoE Balance Sheet 0 50 100 150 200 250 300 350 400 Oct-09 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 BoE Source: Deutsche Bank OIS pricing 0.30 0.35 0.40 0.45 0.50 Current % Source: Deutsche Bank, Bloomberg Financial KP Spot vs Forward Libor-OIS Basis 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 Jan-09 Oct-09 Jul-10 Apr-11 Jan-12 Spot Fwd (4th contract) Source: Deutsche Bank, Bloomberg Financial LP Current bases compared to history 0 10 20 30 40 50 60 70 80 90 100 Spot 1 2 3 4 5 6 7 8 1Y Range Current 1Y Average Source: Deutsche Bank 2 July 2012 Fixed Income Special Report Page 8 Deutsche Bank AG/London Decline in 3M Sterling Libor Fixing -5 -4 -3 -2 -1 0 1 2 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Daily Changes bp 10d Rolling averages Source: Deutsche Bank Fwd Bases 0 25 50 75 1st 2nd 3rd 4th 5th 6th 7th 8th Current 1M Ago Source: Deutsche Bank, Bloomberg Finance LP Secured v Unsecured overnight rates 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 RONIA SONIA Source: Deutsche Bank, Bloomberg Finance LP Money Market Slope 1 1.2 1.4 1.6 1.8 2 2.2 2.4 2.6 -0.25 0.25 0.75 1.25 1.75 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 L 2-6 Slope L 4-8 Slope 1Y1Y (rhs) Source: Deutsche Bank, Bloomberg Finance LP 3m-6m Basis 0 5 10 15 20 25 30 -7 -6 -5 -4 -3 -2 -1 0 1Y 2Y 3Y 4Y 5Y 6Y 10Y 12Y 15Y 1M Change (bp) current (rhs) Source: Deutsche Bank, Bloomberg Finance LP Soniya Sadeesh (44) 207 547 3091 2 July 2012 Fixed Income Special Report USD „ US prime money market funds continue to hold more than 10% of their assets in unsecured European financial institution paper, providing a lifeline of roughly $160bn that could be pulled if conditions worsen in the region „ Over the past three months, the sector pulled an estimated $ 52bn in funding via holdings of CDs and finance company commercial paper from Europe and replaced the bulk of that amount with CDs and commercial paper in Canada and Japan, according to our review of the largest prime money fund portfolios „ Money funds had already drained the bulk of their unsecured exposure to the Eurozone periphery last year, and our review of the largest funds shows that they face direct exposure today only to the “core” of the Eurozone: the Netherlands (4% of assets), Germany (1.7%), and France (0.4%). The bulk of the outflows from the region came from non-Eurozone Europe, particularly the UK and Scandinavia. Germany, by our estimate, actually saw net inflows from U.S. prime money funds in finance company CP and CDs, although money funds allocate a much larger share to the CD and CPs of Dutch banks „ To avoid overstating the regional exposure, we focus on the largest unsecured obligations, accounting for about $4 in $10 of prime money fund assets, and exclude repo lending, given the generally high quality of the collateral held. Including all assets, the European exposure of money fund is running at about 30%, and about 14% to the Eurozone „ Pure risk aversion may explain only a portion of the recent changes in regional exposure of money funds to Europe. First, European banks are deleveraging and de-risking and may be selling dollar-denominated assets, reducing the demand for dollar funding. Second, to comply with U.S. regulations limiting exposure to banks with second-tier short-term credit ratings, money funds may have been proactively reducing exposure to paper from global banks that had been placed under watch for a downgrade by Moody’s. Third, finance companies and banks from Canada and Japan may be offering more attractive rates to money funds (Please see the Fixed Income Weekly 29 June, US Overview section for further details) Money funds pulled an estimated $52bn in unsecured funding to European finance companies over 3M CDs and Commercial Paper ($bn) Region Feb May/June Difference Eurozone 109 87 -21 Rest of Europe 106 74 -31 Rest of World 377 418 41 Total 592 580 -12 Source: Deutsche Bank Mutual Fund companies, Note: Figures are extrapolations based on the exposure of prime money funds with $371 bn of the $1.4 trillion market. Eurodollar Strip: Level and Spreads Current % 1M Change bp Current bp 1M Change bp U2 0.48 -8 U2/U3 8 -2 Z2 0.50 -11 Z2/Z3 9 2 H3 0.53 -10 H3/H4 8 1 M3 0.55 -9 M3/M4 10 -1 U3 0.56 -9 U3/U4 13 -3 Z3 0.59 -9 Z3/Z4 17 -5 H4 0.61 -9 H4/H5 23 -7 M4 0.65 -10 M4/M5 30 -7 U4 0.69 -12 U4/U5 37 -6 Z4 0.77 -14 Z4/Z5 42 -5 H5 0.84 -16 H5/H6 48 -3 M5 0.94 -17 M5/M6 51 -2 U5 1.06 -18 U5/U6 52 -1 Z5 1.19 -19 Z5/Z6 54 0 H6 1.32 -19 H6/H7 53 0 Source: Deutsche Bank, Bloomberg Finance LP Fed Funds Pricing Current Incremental change % Hike/Cut* Cumulative Changes % Hike/Cut* Jul-12 0.170 8 32% 8 32% Aug-12 0.175 0.5 2% 8.5 34% Sep-12 0.180 0.5 2% 9 36% Oct-12 0.180 0 0% 9 36% Nov-12 0.180 0 0% 9 36% Dec-12 0.180 0 0% 9 36% Jan-13 0.180 0 0% 9