EURUSD Basis Spreads to Trend Backwards To -50pbs Floor

On the EURUSD basis in particular we continue to expect policy divergence to dominate. We expect EUR issuance to increase on expectations of further ECB QE in December, maintaining downward pressure on the basis. We continue to expect the 5y EURUSD basis to test the –50bps floor. – TD Securities

New research from TD Securities suggests the present relief seen in EURUSD basis spreads is due to come to an end.

The following assessment, with respect to the EUR/USD basis, defines net issuance as USD issuance initiated by Euroarea entities minus EUR issuance initiated by US entities.

To identify near term shock to the basis, TD Securities focused on seasonal patterns in issuance activity.

They discovered a decline in net issuance around the end of year, and attributed this to investors hoarding USD liquidity. This result in falling basis spreads (more negative).

And then at the start of the new year, a reversal in net issuance is identified, with net issuance higher.

In spring, net issuance will rise again and rise even more in autumn, resulting in “a bias to pay the basis thereby making the basis less negative.”

Deviated Pattern Due To ECB QE

In the 2014-2015 turn, TD Securities saw a deviation from the usual patterns noted above.

Likely due to expected European Central Bank (ECB) quantitative easing (QE) programme, the USD issuance activity by EUR based issuers was not as strong, if going on seasonal patterns.

This resulted in low net issuance and more negative basis:

“Indeed net issuance reversed sharply in February, coinciding with ECB QE and the resulting oversupply of EUR currency relative to USD.

“Given this we saw a sharp move lower in the basis, which troughed at –38bps by mid-march. Net issuance continued to fall in the spring and again in September, resulting in the 5y EURUSD basis remaining around the –35bp level.

“As a result of the fall in the basis there was a sharp increase in net issuance in October/November (as a result of increased USD issuance), however the basis continued to fall all the way down to –43bps on the back of policy divergence — October was marked by a dovish ECB press conference and strong US data, which caused the market to re-price higher the possibility of a Fed hike and further ECB QE in December,” states TD Securities.

End of Year Seasonal Decline and ECB Stimulus to Push EURUSD basis spreads to -50bps Floor

Due to an expected seasonal net issuance decline and another round of ECB stimulus in this season, TD Securities expect a further decline from the norm.

Already, news reports are that the ECB will be aggressive with their new stimulus programme in an effort to surprise the markets.

TD Securities speculates, “As such, the recent respite in EURUSD basis spreads should reverse and the trend lower in basis spreads should continue.

“Indeed as noted previously we continue to expect EURUSD basis spreads to trend back down towards the –50bps floor.”