Icap’s weekly European repo report shines some light on recent eurozone bond developments.
For example, it blames illiquidity in German bond markets for causing chaos in the asset class rather than a sudden change in mindset. The illiquidity, it says, is specifically related to the perceived virtue of the asset (everyone wants to buy the bonds outright) rather than a sudden rush for the exit.
More to the point, Icap picks up on another interesting trend.
Repo durations are getting shorter, especially in bond collateral markets like France and Finland, a fact which is driving up volumes as churn rates increase:
We continue to witness a push towards shorter maturities in repo markets – both in terms of shorter dated collateral and shorter trades. The result is seen clearly in the rising nominal volumes for many core Eurozone markets running through BrokerTec’s trading platform, boosted as they are by the higher churn rate that accompanies a shift from term-financing into the day-to-day maturities.
But while that’s the trend in France and Finland, it’s the exact opposite in Germany, where volumes are remaining stagnant simply because market participants are finding it near impossible to find any bund collateral whatsoever for financing repo deals :
As Icap notes, demand for term bund collateral is such that repo rates are even hitting negative territory (our emphasis):
The German market, however, represents a notable exception to this higher churn rate for core Eurozone markets. The chart (above) highlights the fall-back in short-dated repo business in this market in recent weeks which highlights the degree to which the strength of ‘buy and hold’ demand is draining liquidity from the market. Something that is also evidenced in trading patterns and price action across the German repo market. The ongoing ‘specialness’ of the German GC curve versus EONIA and other GC curves stands testament to the enduring clamour to hold German paper. 3mth German GC dropped as low as 0.12% last Wednesday.
The German GC curve also gives a clue as to the deeply illiquid nature of the German govt bond market which is driven both by those increasingly keen to hold onto the asset and a self-reinforcing liquidity drain springing from its decreasing use as collateral.
There is very little term business going on at negative levels which again reflects the lack of demand pressure on particular bonds and stands testament to the lack of appetite tfor positioning in the underlying govt market and, in particular, limited pressure to short the market. Short positions that do exist are tending to be funded in the short dates until such time as a positive term rate becomes available. (Although we may see more trading in negative territory in coming weeks as we approach Dec futures expiries.) Also of note, there is little evidence of squeezes on specific bonds reflective a lack of desire to run short positions.
Get that? There is hardly any short positioning in German bunds whatsoever. If there is, it’s on a very short term basis.
The wider context being:
The drop in term trading has been particularly acute in peripheral markets (especially Italy in the wake of the LCH initial margin hike on November 9). However, the big exception is Germany where we continue to see strong demand to lend out in the term-dates, especially in three months where counterparties who lack access to the ECB’s deposit facility seem to be prominent on the bid-side of the market.
Spanish names are still out there raising funds against Spanish govt. securities but there is growing evidence of demand among international lenders to accept only the shortest dated paper in return. Also, as something of a first for GC repo markets, at least in the memories of ICAP brokers, the BrokerTec platform has, in response to client interest, set up a sub-5 year Spanish GC basket. Sub-10 year baskets are very much the norm across all the other euro GC markets but sub 5 year seems to be a first.
So to summarise:
1) If you happen to own bunds you can, at the moment, fund yourself extremely cheaply for long periods of time in the repo market using those bonds as collateral — largely because everyone else who holds German bunds is refusing to part with the bonds, even for extremely cheap financing.
2) If you happen to own French or Finnish bonds, you can still fund yourself easily, but most likely for much shorter durations than you were used to. This market has now become the go-to market for repo financing (while it used to be Italy).
3) If you happen to own periphery debt, you can only fund yourself for extremely short periods of time — and even then, only if you use short-dated debt. Longer-dated Spanish bonds, for example, are no longer deemed acceptable as collateral by the market, as Icap notes above.
And that’s really the issue. The hopscotch nature of what is deemed as acceptable collateral in the repo market, and more importantly the repercussions of collateral shortages therein. Since repo is the primary funding sources nowadays, that’s the equivalent of taking the last remaining funding lifeline away from banks.
And while the ECB might be able to step in as pawnbroker of last resort (POLR), at least for anything other than German bunds, the irony is that sort of move would only heighten the problem by encumbering more collateral at the ECB.
Which means, if anything, bunds could do with a little less love. Or, at the very least, Germany should consider more debt issuance or a quasi-debt issuance programme like that of the Fed’s SFP or the RBA’s CLF.
Of bonds and automobiles – FT Alphaville
When a government bond becomes a Giffen good – FT Alphaville
One Eurobond to rule them all – FT Alphaville
Bunds get Junckered, and other repo dysfunctions – FT Alphaville
Bund auction reaction, the liquidity case – FT Alphaville