Money markets rise in long term rates may be close to end

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Aug 22 A recent improvement in economic data has pushed long-term euro money market rates away from their record lows, but the rise may hit a wall as they approach levels seen before the ECB cut its main interest rates in July. As short-term interest rates have held steady at ultra-low levels for months, investors and strategists are increasingly looking at derivative products that project money market rates into the future. These products are often referred to as the long end of the money market curve and have seen increased volatility recently, offering more trading opportunities. German and French data showing the euro zone's two largest economies avoided recession in the second quarter, as well as better than expected U.S. retail sales and jobs data have soothed worries about the state of the global economy. Expectations the European Central Bank will take steps to lower Spanish and Italian borrowing costs and calm the debt crisis that has driven much of the euro zone into recession has also driven money market rates higher. But analysts think developed economies will at best recover very slowly, prompting major central banks, including the ECB, to maintain easy monetary policy for a prolonged period. And a lack of detail about the ECB's plans is keeping uncertainty high about their effectiveness.

Financial products projecting the overnight euro zone Eonia rate four years into the future trade at 0.43 percent, compared with a record low of 0.2872 percent hit in late July. Three-year Eonia traded at about 0.24 percent, having risen from a record low of around 0.12 percent in July, when, in a sign of how flat the curve was, spot Eonia was at a similar level. Spot settled at 0.103 percent on Tuesday."If risk appetite is improving and there's a feeling that bad economic data is already priced in then these rates ... will be rising, but how far they can go is limited," said Vincent Chaigneau, head of fixed income strategy at Societe Generale. Long-term Eonia rates now trade just below levels seen before the ECB cut the main refinancing rate to 0.75 percent and the deposit facility rate to zero on July 5.

Max Leung, an interest rate strategist at Bank of America Merrill Lynch Global Research, said this was a sign that the rising trend may be coming to an end. PLAYING BLUES

Leung recommended investors place a bet on a drop in one-year Eonia rates starting in three years, rather than the four-year spot Eonia, due to more attractive levels. He said the rate, also known as 3y1y forward Eonia, or blue Eonias, could drop by 20-25 basis points from current levels of around 0.98 percent in the next two-three weeks. JPMorgan rate strategist Fabio Bassi also has a "bullish bias" on blue Eonias, even though he had no specific trading recommendation on them."There is a lot of event risk on the table in the next few weeks, and a lot of uncertainty about the ECB (intervention) plans," Bassi said. The ECB meets next on Sept. 6. JPMorgan expects the ECB to cut the deposit rate to minus 25 basis points in September or October and Bassi recommended betting on a fall in October-dated forward Eonia rates, now trading at around 5 basis points."The risk/reward is such that if they (the ECB) cut the deposit rate to -25bp, (October Eonia) could fall as low as minus 10. If they don't, then you only lose 4-5 basis points," he said.