EUR Money Markets: Tightening as intended
The desk is asserting that the European Central Bank (ECB) may be overestimating the number of rate hikes, given current liquidity conditions and market response. The source notes that while the market pricing anticipates up to four more hikes, the desk disagrees, projecting only one additional hike that would elevate the deposit facility rate to 2.75%. Per the full note , this skepticism arises amid high uncertainty, particularly influenced by geopolitical tensions post-US midterm elections. The consensus target for EUR/USD sits at 1.1700, with forecasts ranging significantly across firms, underscoring the variability of market sentiment. Traders should remain vigilant, as any shifts in market liquidity or ECB policy could spark revaluations.
What the desk is arguing
The desk believes the ECB's pricing for rate hikes is overly aggressive and unlikely to materialize as expected. Per the full note , this perspective is informed by a tightening of liquidity conditions and a challenging geopolitical landscape.
Short-term rates are moving upward as the ECB reduces its balance sheet, but the desk anticipates only a single rate increase rather than the multiple hikes that markets are currently pricing in. For instance, potential liquidity pressures from repo markets could lead to sharper rises in money-market rates, but this will have to be managed carefully.
Where it sits in our coverage
Our consensus target for EUR/USD is 1.1700, with forecasts ranging from 1.1200 to 1.2000. Specific targets include: - socgen: Dec26 1.1400 - barclays: Dec26 1.2100 - rbc: Dec26 1.2000
This outlook is slightly more conservative than the broader expectation among analysts, as many are projecting higher rates in the short to medium term.
How other firms see it
Analysts at firms like morganstanley and rbc align with a bullish view on EUR/USD, projecting levels of 1.2000 and above. In contrast, danskebank holds a more cautious stance with a target of 1.1100, reflecting a divergence in expectations regarding ECB policy.
The trajectory of EUR/USD is also relevant as it may be influenced by the broader market's reactions to the USD/JPY interactions and ECB policy changes.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The desk doubts the market's pricing of aggressive ECB rate hikes, favoring a more conservative outlook.
- 02Liquidity conditions are tightening, influencing money-market rates significantly.
- 03Current forecasts show a wide range for EUR/USD, indicating diverging views across firms.
- 04Geopolitical tensions may impact ECB decisions and market expectations moving forward.
Market implications
Traders should focus on the EUR/USD levels around 1.1700 and be prepared for surprises around liquidity adjustments. Monitoring repo market rates will also be crucial, as they may signal liquidity stress affecting short-term rates.
Risks to this view
A reversal in this outlook could occur if geopolitical tensions escalate, forcing the ECB into more aggressive tightening than anticipated. Additionally, should liquidity conditions stabilize unexpectedly or enhance, this could shift the market's perception of ECB rate paths significantly.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
J.P. Morgan | Bearish | 1.1300 |
Crédit Agricole | Bearish | 1.1300 |
Goldman Sachs | Bearish | 1.1200 |
Articles EUR Money Markets: Tightening as intended Published 09:01 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download The ECB hike discount is stretched, but hard to lean against given the high level of uncertainty. Liquidity conditions will continue to tighten. Repo markets should absorb the adjustment, but a higher reserve requirement, year-end pressures or ECB borrowing stigma could still trigger a sharper rise in money-market rates Benjamin Schroeder ECB pricing is looking increasingly stretched The European Central Bank faces a challenging backdrop of renewed energy market stress alongside surprisingly resilient economic growth, as reflected in the latest flash PMIs.
This mix has pushed short-end rates to price in a tightening cycle that sees three to four more hikes over the next year. We think this is too much and expect only one more hike from the ECB, taking the deposit facility rate to 2.75%. But we have to acknowledge that this outlook largely hinges on the assumption that geopolitical tensions will start to ease after the US mid-term elections.
Liquidity conditions tighten and approaching critical thresholds Money markets face progressively tighter liquidity conditions as the ECB continues to shrink its balance sheet and transitions to a new operational framework for implementing monetary policy. The new framework, introduced in 2024, aims to nudge banks into a more active role, using liquidity operations as part of the ECB's day-to-day liquidity management. The ideal is a self-balancing system where banks decide how much liquidity they need while the ECB continues to offer unlimited liquidity at a fixed rate.
By design, as excess liquidity continues to decline, short-term rates are expected to rise. The indicator the ECB appears to watch closely is the repo market. Officials have indicated that repo rates moving toward the rate charged on the ECB’s one-week main refinancing operations (MROs) would be consistent with the framework functioning as intended, since banks would increasingly have economic incentives to substitute market funding with ECB refinancing operations.
At a later stage, the ECB plans to introduce both structural refinancing operations and a structural bond portfolio aimed at supplying a baseline level of reserves. The objective is to cover the structural liquidity demand arising from reserve requirements and autonomous liquidity factors such as banknotes in circulation. One issue that the ECB has not yet solved is that funding via the ECB comes with a perceived stigma.
That is what could lead to a more noticeable squeeze higher in money market rates. Excess liquidity is at €2.12tr at the moment. Current estimates suggest banks may wish to operate with somewhere between €1.5tr and €2tr of excess liquidity, although uncertainty remains substantial because observed reserve demand under the new framework is untested.
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