One Investor Bets on Doomsday Scene Needing Monster ECB Cut

(Bloomberg) --

The European Central Bank put the onus on banks to fund the pandemic-hit economy’s recovery when it loosened loan conditions last week, but investors may be beginning to bet that won’t be enough.

One trader has amassed over 100,000 options on interest-rate futures this week that will hit pay day if the ECB slashes its benchmark rate to minus 1% by early next year, according to a trader in London who asked not to be named as he isn’t authorized to speak publicly. The institution’s deposit rate is currently at minus 0.5%.

In its April 30 policy review, the central bank tweaked the rate on long-term loan facilities to encourage banks to borrow more and promote lending -- effectively easing funding conditions. But actual rate cuts may be in order if the indirect measures fail to support an economy that the ECB sees contracting by as much as 12% this year.

The options will pay out if March Euribor futures, which are tied to the rate at which banks borrow from one another, rise above 100.75 from 100.44 currently. That would require the three-month Euribor rate to fall by almost 50 basis points from the current level of about minus 0.27%, which is only possible if the ECB lowers the deposit rate to minus 1%.

In theory, potential profit from the trade is limitless because the ECB can cut rates indefinitely, but it will make at least 60 million euros ($65 million) if the March Euribor future rises to 101.00, equivalent to a rate cut to around minus 1.25%. The investor can also chose to sell the position any time before March and can profit if bets for further rate cuts increase in the market.

While money markets only expect 10 basis points of ECB cuts by March, Norway’s central bank surprised investors Thursday by slashing rates to zero.

©2020 Bloomberg L.P.