Forget EURIBOR And Basis-Swaps; EUREPO Curve Inversion Signals Major European Funding Stress

Tyler Durden's picture

It would appear that one-by-one the open-market indications of stress in European funding markets are manipulated to the point of worthlessness. As the provision of unsecured lending is for all intent and purpose finished in Europe, LIBOR is a mirage and even cross-currency basis-swaps (though modestly margined) have lost their 'signal' as MRO/LTRO reduced the term-funding need. However, as recently highlighted by @SoberLook, the EUREPO curve - which measures how much banks have to pay to borrow, when pledging or repo-ing assets, for loans - is not only un-manipulated as of yet but is flashing very bright warning signals that all is absolutely not well in European bank liquidity. The 'signal' that is clear is the inversion of this curve, which means simply that it is significantly more expensive to repo (borrow) in the ultra-short-term than for a much longer-term. This is likely due to the banks' need to fund deposit outflows, thus requiring the banks to 'find' that cash (by 'lending' their assets as security for the loan). The loss from the counterparty bank seizing your collateral if it went broke is far higher over a longer-period and thus there is a very strong preference to only repo overnight relative to 3 months, for instance. This repo curve inversion signals a total lack of trust among European banks (in even the shortest of tenor), no belief in short-term 'bailout effects' lasting more than weeks,  as well as a huge demand for cash (repo) that suggests deposit outflows remain very active.

The following charts shows the gradual inversion of the EUREPO curve from its 'normal' upward-sloping levels of 3/28 to its massively inverted shape currently...

 

...and over time it is clear that the shortest-end of the repo curve (overnight lending - solid green) has become - in the last few weeks - the most in demand relative to the rest of the short-end of the curve (1 month repo - dashed green).

While these levels are indeed indicative of funding stress they are not at 'catastrophe' levels yet though the acceleration of the inversion is very worrisome...

And as a reminder EURIBOR (unsecured lending) is a fallacy and the levels are simply not real (providing no stress signal)...

...and USD term funding needs (via the EUR-USD cross-currency basis swap market) has been 'mitigated/manipulated' by Fed swap lines and LTRO/MRO (making it worthless as a signal of stress unless it begins to seriously crash again)...

...though mid-term basis-swaps (post LTRO) show some signal, it is the short-term liquidity needs of banks that is the concern and the EUREPO curve is where to look for any signs of further stress or easing (especially when considering the +/-5% swings in stock prices among European banks currently).

Charts: Bloomberg