Oh dear. So much for the big Draghi LTRO helping out the Eurozone collateral crunch.
According to Icap’s latest repo makret report — and remember they operate the dominant electronic repo platform in Europe, Brokertec — the collateral crunch hasn’t eased at all.
As Icap noted on Friday:
The collateral squeeze in Eurozone repo markets continues. Repo trading volumes have dropped sharply across the board. This is not a seasonal dip but a genuine large-scale slide in repo market liquidity which appears to be driven by a sharp squeeze in available collateral. Overall repo volumes transacted on the leading Repo system, Brokertec, have fallen around 30% from mid-Q4.
Notably, the initial slide in volumes was focused on the German govt repo market, seemingly related to escalating levels of risk aversion depressing secondary govt bond market activity and encouraging buy and hold strategies. German GC rates have pushed close to zero and traded negative on occasion for non-standard settlement or credit sensitive names. The drop in Euro repo volumes over the past month has been spread across all major Eurozone repo markets.
And here’s that volume plunge in chart form:
Over in the world of repo rates, meanwhile, there was another interesting development. The hugely elevated state of Italian repo rates, it turns out, staged a miraculous reversal from about mid-December onwards:
What’s weird about that, notes Icap, is that the plunge coincided with Italy’s 10-year bond spread over core AAA Eurozone countries widening above the 450bp ceiling indicated by LCH as a key indicator for further additional margin charges. This is counterintuitive because plunging repo rates should hypothetically be associated with rising demand for the underlying collateral. Breaching the LCH limit would conventionally have translated to higher repo rates, not lower ones.
Of course, the fact that the Italian plunge coincided with the ECB’s LTRO three-year tender didn’t go unnoticed. If anything, the coincidence may suggest that the central bank’s decision to gobble up huge amounts of Italian government debt from the secondary repo market was always based on a want to suppress Italian (and Spanish) repo rates.
As Icap notes:
This collateral contraction helps to explain both the reduction in repo trading volumes and the drop in Italian (and Spanish) repo rates in recent weeks.
So, to summarise, while it appears that the LTRO failed to ease Europe’s underlying collateral crunch, it did potentially succeed at converging Eurozone repo rates. These, as we previously reported, had gone splitsville, a fact which may or may not have compromised the ECB’s policy transmission mechanism:
Interestingly, now that all the unwanted Eurozone debt is safely banged up at the ECB, renegade GC rates have indeed begun to converge around Eonia:
This, we presume, is what the ECB always intended.
After all, it’s impossible to shepherd a flock to market if some key members have been led astray. But with the group now reunified, the assumption is that it will be much easier for the ECB to lead all rates collectively out of danger.
Assuming, of course, that the act of reunifying the group didn’t compromise the flock in some other way (say by leading them in entirely the opposite direction of the market they were originally intended for).
Could the collateral crunch prove more dangerous than the original bond-yield divergence?
We guess, only time will tell…
Collateral shifts in the eurozone – FT Alphaville
Bunds get Junckered, and other repo dysfunctions – FT Alphaville
Italian settlement fail penalty, bond sell-off — causation or correlation? – FT Alphaville