Heightened expectations that the European Central Bank will cut interest rates in line with the Federal Reserve following last week's 50 basis point U.S. rate cut are driving demand for over-the-counter Euribor corridor swaps. The trades are designed to take advantage of the growing interest-rate differential between ECB and Fed short-term rates, explained Mathias Echene, v.p.-structured products marketing at Schroder Salomon Smith Barney in London. Investors in Germany, France Belgium and Luxembourg have been piling into the positions in sizes of USD50-100 million (notional), he said.
Deutsche Bank, Lehman Brothers, BNP Paribas and Société Générale are among the most active structurers of these products, according to bankers and an end user. Officials at Deutsche and Lehman confirmed their involvement, declining further comment. Calls to SocGen and BNP were not returned by press time.
In a typical transaction, investors enter a one-year swap in which they pay three-month Euribor and receive Euribor plus a spread. The payout is determined by calculating the number of days three-month Euribor remains within a corridor chosen by the investor, for example below 4.75% and above 3.5%, SSSB's Echene said. The trades have also been structured in the form of principal-protected structured notes, as well as swaps with resettable upper and lower levels on the corridor.
"The ECB will only lower interest rates over the next year because the spread between [U.S. and European rates] can't remain as wide as it is," Echene commented.
