Money Market Update: Blame the French banks?

Summary

• Factors beyond the ECB's control have kept the Eurozone unsecured money market relative loose, and thus ESTR and BOR spreads wide. This year alone, peculiarities on the ECB’s balance sheet have offset half of Quantitative Tightening. QT should have tightened the unsecured market significantly, but that has not happened – yet;

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• The repo market has tightened significantly and will tighten further because of the tidal wave of collateral: both new issuance and released by the ECB. Repo borrowing by French banks – and French banks alone – jumped this year, coinciding with the rise in spreads. Cash instead of collateral is now king in the secured market;

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• The level of bank reserves in Italy is low and has returned to pre-pandemic levels. There is now structural demand for ECB main refinancing by Italian banks. Six months from now, the level of reserves in France will likely fall to borderline low levels. Expect recourse to Main Refinancing to rise further gradually next year – stigma be damned;

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• The unsecured market will finally tighten in 2025, but do not expect any secured market-like fireworks. For a while longer we will be at the modestly – not steep – upward sloping part of the demand curve for bank reserves.