Borrowing costs

Influx of cash pushes borrowing costs to unusual levels in Europe

Too much money for too few assets creates strange phenomena at the heart of European financial markets.

A striking example: some companies and most banks can now borrow at rates lower – and even below zero – than the rate set by the European Central Bank.

Italy’s Enel SpA, one of Europe’s largest power producers, has short-term commercial paper that recently offered an annualized return of minus 0.61%, according to FactSet: that’s 0.11 percentage point less than the ECB deposit rate of minus 0.5%.

When interest rates are negative, borrowers pay back less than what was loaned to them when their debt matured. At Enel’s rate, if he borrowed $ 100 for a year, he would repay $ 99.39.

For the lender, in this case the money market funds that buy commercial paper, the reverse is true. They get less money.

“It took a few years for customers to understand the idea that they should pay to leave money in a safe place,” said Kim Hochfeld, Global Head of State Street.‘s

cash case. State Street’s EUR Liquidity LVNAV fund, worth € 6.6 billion, equivalent to $ 7.9 billion, returns minus 0.68% after fees, but that compares to total costs on major bank deposits of up to 1%, she added.

Borrowing costs below the central bank rate in any economy are unusual. There are parallels to other distortions in financial markets that have emerged since central banks triggered massive monetary support to help economies through Covid-19 lockdowns. The distortions include soaring prices for stocks and high-risk assets such as bitcoin.

Negative rates have been a reality in the eurozone since 2014, but in money markets they have been pushed even lower during the pandemic by the ECB’s cheap bond and loan programs. It has also pushed some long-term government bond yields below the deposit rate: German 10-year yields have spent most of the time since last September below the deposit rate although they have fallen below the deposit rate. above this month.

Support from the central bank has also helped companies issue record amounts of longer-term bonds, giving them enough money to weather the loss of normal income when economies are stranded. Some are sitting on mountains of money.

The stop-start style of social and economic life has also reduced spending by consumers and businesses, leading to the accumulation of savings. European money market funds, often used as an alternative to bank deposits, have reached record levels of 1.4 trillion euros, according to ECB data.

Businesses and banks don’t need the money these funds have to offer. According to CMDportal, a bond and monetary data aggregator, the four-week moving average of weekly commercial paper issuance is down nearly 40% since the start of 2020.

Average rates plunged in response, to around minus 0.55% in January, according to David Callahan, money market fund manager at Lombard Odier Investment Managers.

“There’s a lot of cash flowing around and the rates are very low,” Callahan said. For investors who put their money in commercial paper, “it’s a bit like death by a thousand denominations,” he said.

Enel is one of the largest commercial paper issuers in Europe and has over 2 billion euros outstanding over various maturities. It has a short-term credit rating of A2 and a normal credit rating of BBB-plus, near the lower end of the investment grade.

A spokesperson for Enel said the company will continue to use the commercial paper markets when it is the most efficient source of funding.

Market borrowing costs below the ECB’s interest rate are visible in other areas. In the repo markets, where overnight loans are backed by government bonds, the borrowing rate against German bonds, for example, is minus 0.634% on an annualized basis.

This is in part due to a shortage of bonds to use as collateral, which Bank of America analysts say could worsen as the ECB continues to buy more and more debt. At the end of the year, when European banks wish to reduce their balance sheets to meet regulatory targets, rates can fall sharply. The overnight repo rate using German bonds fell to minus 2.3% at the end of 2020.

It’s a similar story in the unsecured interbank lending markets, a staple of financial plumbing where banks lend to each other. Rates such as the short-term overnight euro rate and the longer-term Euribor are benchmarks for lending across the economy, including business loans, mortgages and more. credit cards.

Since mid-December, borrowers have often been able to get for a week a lower rate – minus 0.566% on average – than on overnight loans, at minus 0.562% on average, according to FactSet. This is strange because it is riskier to lend money for a longer period than a short one.

Bas van Geffen, quantitative analyst at Rabobank, said it was a sign that banks in particular simply had too much cash and were moving it to where they could minimize losses from negative rates. “It’s a bit like passing the hot potato,” he says.

Write to Paul J. Davies at [email protected]

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