1/12/17: Eonia’s strange vaulting

What concentration risk and liquidity risk can do to you when both combine?

Eonia (Euro OverNight Index Average) is the 1-day interbank interest rate for the Euro zone. In other words, it is the rate at which banks provide loans to each other with a duration of 1 day (so Eonia can be considered as the 1 day Euribor rate). In other words, it is a measure of short-term liquidity.  Eonia is an average of actual rates charged, so it is, in theory, a reflection of the market demand for short term liquidity. But Eonia is a tiny market, trading normally daily at around EUR7 billion or less. And in a tiny market, there can be a sudden shift in trading volumes. This is what happened on Wednesday and Thursday. Eonia rose from -0.36 basis points on Tuesday to -0.30 bps on Wednesday to -0.24 bps on Thursday.

Eoinia's volumes are 90% direct borrowing by prime banks (and the balance is brokered), so a handful of large institutions use the market to any significant extent. Which induces concentration risk. Worse, Eonia is a secondary/supplementary market, because the ECB currently provides extremely cheap liquidity in unlimited volumes on a weekly basis. Which is another risk to Eonia, as it is thus set to absorb any short term variation in liquidity demand (below 1 week).

Bloomberg speculated that "The most likely explanation is a technical hitch, rather than some sudden crisis warning. The cause of the spike could be a U.S. financial institution that has switched its year-end accounting period from Dec. 31 to Nov. 30. This may have driven a sudden need for short-term liquidity, thereby causing a squeeze. It was month-end for many financial institutions on Thursday, on top of which we are approaching year-end periods, when cash and collateral rates often get squeezed. A bit of indigestion shouldn’t be a surprise. But a move this big is."

If Friday close gets us back toward Tuesday opening levels, the glitch might just be a glitch. If not, something might be happening beyond 'technical' hitches.

The strangest bit is that the move signals a potential liquidity squeeze in a market that has, if anything. too much liquidity. And the matters are not helped by the shallow trading volumes, that imply a concentrated move.

Something to watch, folks, if anything - for just another illustration of the concept of correlated risks.