Maintenance Periods and the Money Supply: Europe vs the United States
Published 2011 in Eurpean Banking Federation Newsletter. Seems incomplete as Australia is missing and others
Maintenance periods is an old issue no longer discussed yet its import should be understood in order to determine the demand and supply of money, interest rate direction and purpose employed through market mechanisms such as Eonia and Euribor in Europe and Fed Funds in the United States. Maintenance periods for central banks defines monetary policy by pricing a nation’s demand and supply of reserves to an interest rate. Yet each central bank that employs a maintenance period deploys those periods in different ways.
A maintenance period for the Eurozone is the time between governing council meetings, an ECB policy rate meeting in market parlance with a purpose to price excess reserves placed by banks on account at the European Central Bank. Reserves are averaged monthly over the maintenance period term. The ECB then provides liquidity to the banking system by bankers who bid for Euros through weekly and three month auctions at the Main Refinance Rate, also termed the Minimum Bid Rate.
The Refi rate is the most important interest rate in Europe because it influences prices in market interest rates such as Eonia, Eurepo (Repurchase Agreement Rate) and Euribor to satisfy ECB policy to bring price stability to the European system based on the ECB Treaty on the Functioning of the European Union Article 127.
Price stability for the European consumer is found within the Harmonized Index of Consumer Prices, a quarterly economic release to measure prices in relation to inflation and the Refi Rate. More importantly, the Refi rate is also termed the base rate because it establishes at what interest rate reserves are expected to grow or contract and appears in M3 money supply forecasts. Reserves are also termed the money supply, interest rates are termed reserve rates and reserve requirements are the terms of reserves vs deposit liabilities, sometimes called the cash ratios due to focus on balances in accounts.
Excess reserves are paid an interest rate to manage liquidity. For the European system, the overnight rate termed Euribor or the Euro Interbank Offered Rate is paid on excesses for the short term. Reserve deficits are charged an interest rate termed Eonia, Euro Overnight Index Average and a weighted average of Euribor. Eonia is the rate bankers charge each other for overnight loans and represents the floor of interest rates. Eonia is an effective rate to Euribor that trades contracts from one day to 24 months with a Fix time of 19 CET, 1:00 p.m. New York after European market closes.
Excess reserves once priced are loaned throughout the banking system to multiply Euros by borrowing at the Eonia rate and lending at Euribor. Euribor is a term deposit, fixed at 11:00 a.m Central European Time, 5:00 a.m. New York with 1 week to 12 month lending terms with a T+2 two day spot value. Spot value dates establishes foreign banks in different time zones to adjust their own books within their own trading hours.
Notice not only Euribor establishes loan rates for mortgages, consumers, major companies but are indexed through Fixed Rate Tenders and offered by the ECB since 2008. A Fixed Rate Tender simply allows the ECB to offer money, Euros at a fixed price. This represents what is known as the interest rate corridor or channel for the European system that establishes a floor and ceiling of daily interest rates.
The Fixed Rate Tender forces money into the interest rate channel by pricing liquidity at a desired price and allows a Maintenance period time to maintain its existence throughout policy meeting to policy meeting.
The purpose of the 1999 introduction of these short rates is to price reserves on a daily basis and gives indication of the demand and supply of Euros to meet the three month, money supply refi target rate. Above the target means inflation and an erosion prices, below means deflation. Both are an uncertain cost to reserves.
Euribor rates are established through an average of bids and offers for Euros by bankers who comprise the panel of bankers at the European Banking Federation in Brussels. Once the rate is released, bankers with excess reserves loan Euros at OIS Euribor- Libor + 100 basis points while bankers with deficits borrow.
The 100 basis point figure is derived from the size of the interest rate corridor as corridors change with expansion and contraction of interest rates over time. If the price of Euribor interest is not sufficient to meet a deficit nor sufficient to meet Euro supply, bankers can swap Euribor interest rates in another currency.
Euribor then transforms terminology to an Overnight Indexed Swap rate. If the swap was completed with OIS Euribor-Libor and OIS-Fed Funds, bankers would buy/sell or sell/buy. With present lower interest in the US compared to the Eurozone, bankers would sell OIS-Fed Funds and Buy OIS-Euribor. The proceeds of OIS-Fed Funds is added to OIS-Euribor for one week to 3 months or longer in order to meet the insufficiency of interest in the Eurozone.
What is funded within the demand/supply, deficit/surplus equation from a bankers perspective are deposits not only in Euros but Swiss Francs, US Dollars and British Pounds. CHART of EURO DEPOSITS
Euribor and Eonia are trade able market rates that trade as futures contracts on Euronext based on a 360 day count.
Euribor/Eonia Swap Index futures is one such contract. Euribor prices are quoted in percents to three decimal places as 100 minus the rate of interest, 0.005 equals 12.50 Euros. Eonia trades as 100 minus the traded average effective Eonia rate, 0.005 equals 12.50 Euros.
Since 2008, the one month Eonia contract and the three month Eonia swap index aligned in terms of trade and settlement to central bank maintenance periods. The Eonia three month contract trades normal International Money Market dates while the one month contract is aligned to European maintenance periods. Eonia swap rates is a measure of future overnight rates.
Interest rates and Euribor share an inverse relationship, a rise in the Refi rate will see a decrease in Euribor while an decrease will see an increase in Euribor contract prices.
A trader will find as the money supply increases, Euribor rates decrease while a money supply decrease will see a Euribor increase. Euribor bids and offers are based on one week to 12 month terms for 15 maturities with a Fix time 11:00 CET, 4:00 am New York. Most important is Euribor and Eonia are unsecured loans hence unsecured interest rates. CHART EURIBOR and EURO MONEY SUPPLY.
Eurepo is a secured loan, employed as the repurchase agreement rate. A range of European interest rates is measured by the spread of unsecured rates to the secured interest rates. CHART EUREPO VS EURIBOR
Figures 6.8 and 6.9 are charts of the interest rate corridor for the ECB, US, Japan and the BOE. Each nation has various means to achieve the desired three month money supply target. For the short term, the Japanese employ Call rates, the BOE remunerates and indexes reserves at the Bank rate with Sonia rates as the daily operational guide and the US employs the Fed Funds rate. The Japanese, ECB and the US employs maintenance periods while Australia, Canada and New Zealand do not.
Most important for the Japanese, ECB and the US maintenance period time is short rates establishes the start of the day’s yield curve. The interest rate releases at the predetermined Fix time answers the question long or short a currency pair and/or which pair to swap in interest rate terms. More important is the fix time establishes the pricing of financial market instruments such as government bonds in each respective market.
United States Maintenance Periods
The Federal Reserve Board established in 2008 what it calls maintenance periods. These are weekly periods during which banks must maintain required reserves. Maintenance periods cover 14 consecutive days.
Required reserves began as Reg D that appeared first in the Federal Reserve Act of 1978 then carried forward to the 1980 Monetary Control Act that imposed mandatory reserve requirements. All governments then imposed reserve laws and this gave rise to the need for the British Bankers Association as reserves had to be priced and balanced in line with central bank target rates.
To pay interest on reserves was scheduled for 2011 with passage of the Financial Services Regulatory Relief Act of 2006 but moved forward by Congress to 2008 with passage of the Emergency Economic Stabilization Act of 2008 (Federal Reserve 2010).
Overdrafts are charged and reserves are credited an Effective Fed Funds rate defined as a volume-weighted average rate of trades. Required Reserves are credited an average targeted Fed funds rate minus 10 basis points while excess reserves are credited the lowest targeted fed funds rate minus 75 basis points (Federal Reserve 2010).
With a fed funds target rate currently 0.25 with hardly a possibility to sustain itself above due to crisis conditions, the fed had to ensure this rate would never trade to zero or worse, trade a negative.
Instead they had to shift reserves toward or in line with the target rate. See Exhibits 5.5 and 5.6 and notice that without required reserves, fed funds rates would have traded to 0. Exhibit 5.7 provides actual fed funds trades before, during and after maintenance periods. Notice fed funds target rates are 0.00 to 0.25 so trading ranges will normally fall within this period unless crisis occurs or the market prices in an interest rate hike.
FED Fund rates trades the same as Euribor, money supply increases in US Dollars will see a decreased Fed Funds rate while a decrease in the money supply will see an increase in Fed Funds rates. Fed Funds is a single rate and is measured against an effective fed funds rate. The money supply base measured against Fed Funds is released monthly. This time is reserved for money managers to re balance their books in relation to the money supply and an interest rate.
In conclusion, maintenance periods is an important time between the US and Europe because lend and borrow rates, bids and offers, yield curves and direction of financial market instruments are established for a particular day’s trade not only in the US and Europe but between the US and Europe in terms of a Euro/USD exchange rate. The most important aspect of maintenance periods is the determination in the demand and supply of Euros vs US Dollars. Its an indicator and a valued market tool that should be a regular focus for those involved in the markets.
So a EUR/USD spot price begins a trading day based on Euribor/Fed Funds or Eonia/Effective Fed Funds.
Bank of Japan Overnight Rates
The unsecured Overnight Call Rate represents the base rate that determines Japanese Yen money supply forecasts. As the money supply increases, Call rates decline while a money supply decrease sees an increase in the Overnight Call rate. Its a daily weighted average of uncollateralized loans in the overnight market between Japanese bankers.
The Complementary Deposit Facility, a 2008 invention by the BOJ and the heart of the maintenance period is the conduit where interest on excess reserves, not required are payed.
Euroyen is another call market rate with the same maturities, same unsecured structure but trades offshore as actual/360.
Un collateralized Call rates establish daily loan rates and forms the interest rate yield curve in the Japanese market to price Japanese Government Bonds, the Japanese Yen, repurchase agreements and other financial market instruments.
The current interest rate in the Complementary Deposit facility is 0.10, the top interest rate and remained fixed since Nov 2008. This rate served as the risk free rate. Trading ranges/target for the Uncollaterialized Call rate is presently 0.00- 0.10.
The December 1, 2011 rate traded an average of 0.082% with a maximum of 0.150% and Minimum of 0.050%.
December 2, 2011 saw Uncollateralized Call rates traded an average of 0.077%, a maximum of 0.125 % and minimum of 0.060%. Notice the reduction in the daily averages. In order for the Yen to multiply, bankers must borrow short and lend long to profit or the economic system stagnates. Its the point to determine economic growth.
Important is the Overnight Call rate is an “end of day” rate to mean after Japanese markets close.
It prices Yen in the overnight market until a new price is established. That new price will be found when the British Bankers Association releases EUROYEN Libor at 11:00 a.m. London, 5:00 a.m New York.
More importantly is bank accounts must balance and that is the purpose for Uncollatereralized Call rates. While this may conclude the Japanese maintenance period time to factor reserves and overnight rates, Japanese interest rates continue during market trading hours to price not only the Yen but financial instruments such as the JGB and shorter term T-Bills. Its an extension of banking activities to not only loan funds but to raise and invest funds. CHART UNCOLLATERALIZED CALL RATE HISTORY.
Overnight Call Rate Futures
Contracts are quoted as 100 minus the rate of interest, 0.005 =1250 ( 300,000,000 notional X 0.005 % X 30/360 =1250. One basis point =2,500 Yen so 1250= a 1/2 basis point and 0.625 is a 1/4 basis point.
The contract settles as 100 minus the average uncollaterialized overnight Call rate rounded to the nearest 3rd decimal place and trades between BOJ policy rate meetings.
TIBOR, EUROYEN and TOKYO REPO RATE
During market hours, three interest rates have profound importance, Yen Tibor, Euroyen Tibor and the Tokyo Repo rate. This period changes the Japanese yield curve due to market trading. CHART UNCOLLATERALIZED CALL RATE VS TOKYO REPO RATE.
Japanese Yen Tibor, Tokyo Interbank Ofered Rate, is fixed at 11:00 a.m Tokyo time, 11:00 p.m. New York and is an unsecured Call market interest rate and offered 1 week and 1-12 months against 13 maturities, trades actual/365 and establishes loans during market hours.
The 11:00 a.m. Tokyo time release coincides with a 1 hour market opening so this time is called a Mid Rate.
Tibor is a loan rate but it also represents a deposit rate. A loan/ deposit rate funds not only mortgages and consumer loans but it funds the Yen and other currencies held in Japanese and foreign banks. CHART of TIBOR RATES.
Important is Tibor is the day rate banks employ as a currency swap to satisfy a deficit or surplus, earn interest income and invest funds. A swap for the Japanese banking system is USD, a vitally important currency to the Japanese economic system. YEN FUNDING CHART.
A high or low Tibor rate determines which currency to employ as the funder, sell Yen buy USD or buy Yen, sell USD. Yet Tibor is released as a rate to specifically price the Yen.
The historic problem with Tibor is its offered at the ask or offered rate, a single rate without a bid rate. The released rate is the day’s trading rate for lending and borrowing in the inter-bank money market and called a cash rate because it represents the day’s risk free deposit rate.
The Japanese Bankers Association manages Tibor through 18 Japanese banks who submit bids and offers. The highest and lowest are discarded, remaining bids and offers are averaged and that rate is released at 12:00 Tokyo time, 12:00 p.m. New York. This time represents one hour after Tokyo markets open.
The 18 Japanese banks represent the largest and most capitalized yet thousands of banks channeled by many types such as city, agricultural, rural, cooperatives comprise the Japanese banking system and all are members of the JBA.
Currently 64.9% of banks represent fund raising and 64.2% represent loans as a percentage of market share. In 2001, JBA membership comprised 141 full members, 46 associates and 72 special members so the JBA grew exponentially. (BIS official reports). JBA’s proper Japanese name is zenginkyo and translates roughly as complete bank pride.
Euroyen Tibor is an invention of post World War 2 reconstruction implemented by the US to allow offshore finance of food and supplies to enter Japan. (Fukao 2006).
With a 60 year rocky interval of exchange control laws and early establishment as a bond, Euroyen Tibor was formally established in the offshore market in Dec 1986, internationalized in 1998 by amendment to Japan’s Foreign Exchange Law that allowed a liberalization of international financial transactions after amendment in 1980 that allowed freedom of transactions with exceptions and only offered to certain foreign banks.(Fukao 2006).
With the addition of the 1997 introduction of Japanese derivatives, single stock options and screen based trading between the Osaka and Tokyo Stock Exchange, it appeared Euroyen was completely liberalized but transaction taxes, low interest rates and regulations saw ‘lethargy” in Euroyen trade. (Ito and Lin 1996).
When Nikkei 225 futures arbitrage between the Osaka and Singapore exchanges hindered Euroyen’s function due to volatility swings from separate margin requirements between both exchanges, Euroyen would not become free until formal introduction of the Euro.
Euroyen Tibor is an offshore deposit interest rate to serve Japanese banks overseas, derived by an average of bids and offers from 18 Japanese banks, released the same time as Yen Tibor by the Japanese Bankers Association as a Mid Rate and trades as actual/360.
The actual/360 classifies Euroyen as an offshore rate due to alignment to Europe and the US 360 day count convention. More importantly was the purposeful alignment by WW 2 allies of Euroyen to US Dollars to serve as a funding and/or reserve currency. Yet it is strictly a Japanese interest rate and operates within the same parameters as Yen Tibor.
When Yen money supply increases, Euroyen Tibor drops. It shares an inverse relationship to the money supply.
Euroyen has two profound purposes, an insight into future Yen Tibor deposit rates and BBA Yen Libor, the London Interbank Offered Rate.
As an insight to future Tibor, Euroyen Tibor trades as a futures and options contract not only at the Tokyo Financial Exchange but also at the Chicago Mercantile Exchange, Euronext and the Singapore Exchange, the SGX but once termed the Singapore International Monetary Exchange or SIMEX.
The Singapore Exchange opens at 7:40 a.m. -7:05 p.m. and 8:00 p.m. -2:00 a.m. the next day, 7:40 p.m., 7:05 a.m. New York time and 8:00 a.m. – 2:00 p.m. New York time to coincide with the CME close.
Tokyo opens from 8:45 a.m. to 11:30 a.m and 12:30 p.m.-8:00 p.m.—-8:45 p.m. to 11:30 p.m. and 12:30 a.m., 8:00 a.m. New York time. Singapore time is ahead of Tokyo one hour so Euroyen futures and options trades one hour when Tokyo opens.
Therefore, arbitrage and hedging opportunities occur in Singapore markets because it also trades Japanese Government Bonds. JGB’s trade based on yield so a long JGB position can be hedged against Euroyen Tibor.
Euroyen Tibor is a deposit rate and trades at times as future Yen Tibor because Yen Tibor serves as a daily interbank trading rate rather than a capital market rate.
Euroyen Tibor serves as the key indicator to determine not only future Yen Tibor interest rates but capital market rates, the money market yield curve and supply of Yen. A valid intellectual argument can easily refute these claims for many reasons.
Japanese Overnight Index Swap derives from internal interest rates and connects to Tibor for currency swaps, a 360 day Euroyen yield curve may not always align to Japanese 365 day financial and money market instruments and Euroyen may not forecast Yen money supplies.
Therefore as a key indicator, it fails. Both arguments must be analyzed in the context of Japanese companies establishment offshore since 2006 for purpose of access to cheaper priced commodities and greater profit potential.
USD/JPY was the premiere pair arrangement in this context so Japanese banks offshore can buy US dollars to fund offshore investments especially when the interest rate differential favored the Japanese.
Euroyen, FX Swaps, Libor and Eurodollars was employed as traditional funding mechanisms. During Japanese trading hours, JPY/USD must be traded with Yen Tibor as the focus so the profound conundrum is Japanese markets are closed during overseas Euroyen trade. Its a fascinating interest rate that serves a broad usage.
3 Month Euroyen Futures and 3 Month Options
Trades as 100 minus the rate of interest, 0.005 =Yen 1,250 and settled to the 3rd decimal place. To calculate, from the Tokyo Financial Exchange: if Tibor is 0.12786%, final settlement price is 99.872, 100 minus 0.128.
Options are quoted as Euroyen Futures points, 0.005 with strike price interval=0.125, 0.005=Yen 1,250.
Options settle American style. Singapore and the CME Euroyen Futures contracts trade based on LIBOR, the London Interbank Offered Rate and released at 11:00 a.m. London, 5:00 a.m New York, 2:00 a.m.Tokyo, 1:00 a.m. Singapore.