Published by maria gbaf
Posted on February 23, 2022
By Yoruk Bahceli
(Reuters) -Germany’s finance agency has stepped in to ease a bond shortage that developed in the overnight lending market, a market source said, in a sign of stress following the European Central Bank’s hawkish pivot and more recently the Ukraine-Russia crisis.
ECB President Christine Lagarde’s Feb. 3 refusal to rule out an interest rate hike in 2022 sent traders rushing to repo markets to borrow German bonds to ‘short’ – essentially to bet prices would fall further as rate rises approach.
That increased the scarcity of German bonds, the euro zone’s safe assets used widely as collateral against repo loans, leading to a plunge in repo rates and what investors term a “collateral squeeze.” When euro zone repo rates fall, it becomes more expensive to borrow the securities used as collateral.
More recently, the Ukraine crisis has added to Bund demand. That also likely exacerbated the scarcity, analysts said, though it’s unclear to what extent.
The market source said the Germany’s finance agency, its debt office, had in recent days increased its participation in the repo market, where lenders offer cash to borrowers, often overnight, in exchange for collateral in the form of high-quality assets.
The intervention, which has not been previously reported, is driven by unique characteristics of the German bond market. But it underscores how expectations of the paring back of unprecedented levels of monetary stimulus and growing geopolitical concerns are making investors nervous and can cause stress in unexpected ways.
A sell-off in euro zone government bonds accelerated on Tuesday after the Reuters report, debt analysts said, with two-year German bond yields rising as much as 10 basis points.
The finance agency, which manages Germany’s debt, usually retains a small amount of the bonds it sells, using them for repo transactions and lending them to investors.
It can increase such operations to support the smooth functioning of markets. The source said it also acted at the end of 2021 when a similar collateral squeeze occurred.
The source did not specify the size and start date of the latest activity, or how long the increased participation would continue, but said the participation this month was slightly lower than the “significant” levels seen at the end of 2021.
Responding to a request for comment, a finance agency spokesperson said the agency “provides significant support for liquidity in the repo market in order to ensure the functioning of markets for German government securities.”
“A liquid repo market facilitates market making and position taking in the cash and future markets,” the spokesperson added.
The events highlight how tight the supply of German bonds is; years of asset-buying by the ECB have left it holding nearly a third of outstanding debt.
FALLING REPO RATES
The agency’s action may have started to ease the situation.
Repo rates for trades using German government bonds as collateral across BrokerTec and MTS platforms had plunged to as low as -0.99% last Tuesday from roughly -0.80% a month before, according to RepoFunds Rate data.
By Friday’s close, the repo rate had risen to -0.85%, the data showed.
“We have seen some easing in the scarcity in the repo market so that the rates are rising again,” said Rene Albrecht, strategist at DZ Bank.
Market participants said the latest squeeze was driven by exceptional demand for trades that require specific bonds – dubbed “specials” – where rates fell below -1%, according to the RepoFunds Rates’s index – versus a roughly -0.6% rate on general collateral trades.
“Although bonds trading special is a normal occurrence in the repo market, this has been seen more recently due to short positioning from the market to take directional risk,” said Kate Karimson, BrokerTec’s head of European repo.
(Reporting by Yoruk Bahceli Editing by Sujata Rao, Emelia Sithole-Matarise and Mark Potter)
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