What Is Eonia and Why Is It Worrying Traders?: QuickTake Q&A
(Bloomberg) -- Two sudden spikes in the interest rate for overnight loans between European banks, known as Eonia, got markets fretting and speculating about the reasons for the moves. Markets abhor uncertainty, particularly when the possible explanations include some scary scenarios. Some of that anxiety eased on Friday, as the benchmark interest rate moved back toward more normal range.
1. What exactly is Eonia?
It’s the weighted average of the overnight cost of lending by euro-area banks. Eonia is computed by the European Money Markets Institute, which is also responsible for the more widely known Euribor -- the rate at which prime European banks lend to one another over a longer term. As EMMI defines it, Eonia is a weighted average of all overnight unsecured lending transactions in the interbank market undertaken in the European Union and European Free Trade Association countries. Eonia is based on actual transactions and Euribor is based on submissions by the banks.
2. What happened?
There was an unexpected jump of 6.1 basis points on Wednesday and another spike of 6 basis points on Thursday, lifting Eonia to -0.241 percent. A move on that scale would normally be justified only by a shift in the European Central Bank’s benchmark rate or by funding stress among the banks. In other words, something that made banks far more reluctant to lend to one another, such as one of them having trouble meeting its commitments.
3. How did markets react?
There was heavy selling of futures contracts in the money markets, the home to financial instruments with high liquidity and short maturities. A record number of December 2017 three-month Euribor futures contracts changed hands on Thursday. On Friday, Eonia fell 5 basis points, erasing most of Thursday’s increase.
4. What do people think happened?
The sudden spike may have been the result of excess liquidity injected into the market by National Bank of Greece SA, Greece’s second-biggest lender. Other theories that have been floated involve a possible year-end funding squeeze at some lenders, or demand related to Greece’s just-concluded bond swap. The initial jump spurred speculation that there was an error in the calculation, though EMMI quickly ruled that out. While the rate at which Eonia is fixed tends to rise at the end of a month or year, that typically happens only on the last trading day. Furthermore, this week’s jumps were much more pronounced than the usual end-of-month spikes.
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