Eurozone Liquidity Falls as Euribor-ESTR Spread Widens

Excess liquidity in the euro area has already dropped to about 2.13 trillion euros from a peak of 4.75 trillion euros in 2022, a decline of more than 55%, according to ECB data cited in the report. That retreat has helped lift Euribor relative to ESTR, a dynamic traders say should continue as bank reserves tighten and institutions rely more on market funding.

Barclays’ Rohan Khanna said the trade is the “cleanest, easiest and most visible” way to position for a possible liquidity problem, while ING’s Benjamin Schröder said ECB funding operations still carry a stigma that keeps banks leaning on markets first. Sources said Citadel and Schonfeld Strategic Advisors are among hedge funds active in the strategy, using futures to bet on a widening spread, especially in contracts expiring next week.

For investors, the setup points to more volatility in euro rates and to potential pressure on bank funding costs if reserves keep shrinking. It also raises the odds that lenders tap ECB refinancing tools more often, a development that could reinforce the widening gap between Euribor and ESTR.

The trade will stay tied to the pace of ECB balance-sheet runoff and to whether banks begin to feel enough funding strain to shift away from money markets. That makes upcoming liquidity data, short-term rate moves and any change in ECB tightening guidance the key catalysts.