Eurozone rate futures extend gains

Eurozone interest rate futures extended gains on Thursday with investors piling up bets for a European Central Bank rate cut by the end of the year after the bank flagged downside risks to growth and tamed its language on inflation. The ECB's change in tone reinforced market expectations that a worsening economic outlook in the eurozone and the United States and an escalating euro debt crisis could eventually force the bank to reverse its recent rate increases.
The December 2011 Euribor future rose by 5 basis points to 98.835, implying an equivalent fall in three-month Euribor rates expected for December to 1.165 percent. Euribor futures across the 2012-2014 strip rallied by up to 10 bps in an immediate reaction before paring gains.
The forward overnight Eonia interest rates curve is now fully pricing in a 25 basis point rate cut between November and January and another rate cut by mid-2012, said Giuseppe Maraffino, rate strategist at Barclays Capital. As targets for the trade, he said the November Eonia could fall to 0.65 percent from the current 0.70 percent if a 25 bps cut was fully priced in by November and below 0.50 percent if markets move towards pricing a 50 bps cut.
Money markets have shifted their bets massively since pricing in the end-year key rate at 2 percent when the ECB hiked rates for the first time this year in April. The December 2011 Euribor future has risen by a full point since the April meeting, while the December 2012 contract has gained almost 2 points. As markets were wrong then, they may well be overshooting now.
Credit Agricole's global head of fixed income strategy David Keeble said he thought the current levels in the Eonia curve were not justified and that the markets should be pricing in only a 30-40 percent chance of a rate cut by the end of the year. Interbank stress showed no signs of easing. The three-month cross currency basis swap, which falls when dollar funding strains intensify, hovered near its lowest since December 2008 at below minus 100 basis points. The spread between three-month euro Libor rates and overnight index swaps was also trading near its recent 2-year highs around 70 bps. Analysts see few obstacles in the way of more stress.