Money markets overnight repo rates steady, but may face pressure

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* U.S. overnight repos steady near top of recent range* Europe investors seeking derivatives carrying longer maturitiesBy Chris Reese and Marius ZahariaNEW YORK/LONDON, Sept 21 U.S. overnight lending rates held steady o n F riday at the high end of a recent range, but they could ease early next year after a Federal Reserve stimulus program comes to an end, according to analysts at Barclays. The interest rate on overnight repurchase agreements were last quoted at 0.29 percent, unchanged from late Thursday. Overnight repo rates have generally been trading in a range of 0.17 percent to 0.31 percent since mid-January. Those rates could come under downward pressure early next year after the Fed winds up its stimulus program, dubbed "Operation Twist," under which the central bank is selling shorter-dated U.S. Treasuries and using the proceeds to buy longer-dated Treasuries in an effort to lower long-term borrowing costs like those on mortgages."As primary dealer inventories of Treasuries normalize after the Twist sales end, repo rates, in particular, should start to inch lower," Ajay Rajadhyaksha and Dean Maki, analysts at Barclays in New York, said in a research note.

The Fed last week announced a new open-ended program under which it will buy $40 billion of mortgage-backed securities per month, known as QE3, and said Operation Twist will continue as scheduled through the end of the year. As part of Twist, the Fed on Friday bought $1.784 billion of Treasuries maturing November 2022 through February 2031. Meanwhile, in Europe, investors dissatisfied with short-term interest rates close to zero are increasingly seeking derivative instruments carrying longer maturities, taking the risk of a sudden shift in central bank policy. Record low official European Central Bank interest rates and excess liquidity in the euro zone system of 750 billion euros, according to Reuters calculations, have pushed money market rates to record lows.

Speculation that the ECB could cut its deposit facility rate below the current zero percent, meaning investors would pay a fee to park their money, is putting even more pressure on rates. The overnight euro interbank rate, Eonia, last fixed just below 0.1 percent. Forward financial contracts that represent bets on where Eonia is going to settle at certain points in the future see the rate below 0.1 percent for the next two years. Searching for higher returns, investors are moving toward longer duration. This week, for instance, the four-year Eonia narrowed by 10 basis points to 0.40 percent.

Commerzbank rate strategist Christoph Rieger in Frankfurt recommends bets that the 1y1y Eonia forward -- a financial product that targets the level of a one-year Eonia contract starting in one year's time -- will fall to last month's lows of just above 10 bps from around 20 bps."Even if the ECB does not cut the depo rate further, which remains our base case, prospects of unchanged rates, abundant excess liquidity and potentially lower EONIA-depo spreads should be enough reasons to expand into this part of the curve," he said in a note. Societe Generale rate strategist Ciaran O'Hagan in Paris believes it makes sense to place similar bets even further out on the curve, even if the time period goes beyond the massive three-year cash injections made by the ECB last December and in February. The main risk investors are taking is a possible pick-up in the global economy that could prompt central banks to reverse or discontinue some of their more radical experiments in monetary policy easing. But given the state of the world's major economies and the depth of the euro zone debt crisis, investors seem willing to take the risk."Central banks around the world are going to continue to provide liquidity," O'Hagan said. "The long-term challenges we're facing are so severe and so dramatic that at the moment this is how you want to be positioned."