Market participants utilise overnight index swap contracts to hedge against or speculate on changes in overnight interest rates, which closely correlate with official European Central Bank policy rates and shifts in monetary policy.
These contracts involve the exchange of interest payments rather than notional amounts, making them effective in reducing or transferring interest rate risk to intermediaries.
While some growth in volume is expected as money markets and economies develop, the increase since the first quarter of 2022 has been exceptional.
During 2022, OIS rates deviated from their benchmarking to the ECB’s key rates due to surging inflation and anticipation of rate hikes. The Russian war in Ukraine and energy crisis further contributed to economic uncertainty and inflationary concerns in the euro area, intensifying the need for hedging.
The average daily trading volume in the OIS segment more than doubled in 2022, reaching about €100bn, which accounted for 8% of the total euro money market, compared to 4% in previous years.
In terms of change in annual volume, the total value of outstanding OIS contracts surged to €20.8trn in 2022, marking a remarkable 127% increase compared to the previous year. This growth significantly surpassed the average 34% expansion observed in the overall interest rate derivatives market.
Furthermore, OIS contracts with spot settlement, primarily used for hedging, experienced steady growth as the speed of rate hikes intensified and uncertainty regarding future rate changes grew throughout 2022.
Conversely, according to the ECB’s euro money market study, activity increased significantly in OIS contracts with forward settlement, primarily used for positioning oneself regarding central bank policy rates.
Activity was particularly high around ECB governing council meeting dates, driven by anticipation of rate hike decisions or new signals regarding the monetary policy stance.
Considering these developments and the ECB’s commitment to maintaining higher banking rates “” to achieve the 2% inflation target, it is expected that OIS rates, trading activity and volumes will continue to remain elevated in the short to medium term.
Professor of finance at the University of Luxembourg, Julien Pénasse, that “the greatest source of uncertainty corresponds to changes in monetary policy stance.”
Taken together, the prevailing conditions indicate that an extended period of uncertainty and volatility lie ahead in the money markets.