Band Yoruk Bahceli
February 23 (Reuters) – Germany’s financial agency has stepped in to ease a bond crunch that has developed in the overnight lending market, a market source said, in a sign of strain following the Central Bank’s hawkish pivot Europe and, more recently, the Ukrainian-Russian crisis.
ECB President Christine Lagarde’s refusal on February 3 to rule out an interest rate hike in 2022 prompted traders to rush to repo markets to borrow German bonds at ‘short’ – essentially to bet that prices would fall further as the rate hike approached.
This has increased the scarcity of German bonds, the safe eurozone assets widely used as collateral against repo loans, leading to falling repo rates and what investors call “collateral squeeze”. When Eurozone repo rates fall, it becomes more expensive to borrow the securities used as collateral.
More recently, the Ukrainian crisis has increased demand for the Bund. It also likely exacerbated the scarcity, analysts said, although it’s unclear to what extent.
The market source said Germany’s financial agency, its debt office, had in recent days increased its participation in the repo market, where lenders offer money to borrowers, often overnight, in exchange collateral in the form of high quality assets.
The intervention, which has not been previously reported, is motivated by the unique characteristics of the German bond market. But it underscores how expectations of reductions in unprecedented levels of monetary stimulus and growing geopolitical concerns are making investors jittery and can cause tension in unexpected ways.
The sell-off in euro zone government bonds accelerated on Tuesday after the Reuters report, debt analysts said, with German two-year bond yields DE2YT=RR increasing up to 10 basis points.
The financial agency, which manages Germany’s debt, usually keeps a small amount of the bonds it sells, uses them for repurchase transactions and lends them to investors.
It can multiply these operations to support the proper functioning of the markets. The source said they also acted in late 2021 when a similar collateral squeeze happened.
The source did not specify the size and start date of the latest activity, or how long the increase in attendance would continue, but said attendance this month was slightly below “significant” levels. observed at the end of 2021.
Responding to a request for comment, a spokesperson for the financial agency said the agency “provides significant support for liquidity in the repo market to ensure the functioning of German government securities markets.”
“A liquid repo market facilitates market making and taking a position in spot and futures markets,” the spokesperson added.
Events show how tight the German bond supply is; years of asset purchases by the ECB have left it with nearly a third of outstanding debt.
DROP IN REPO RATES
Agency action may have begun to calm the situation.
Repo rates for transactions using German government bonds as collateral on BrokerTec and MTS platforms fell to -0.99% last Tuesday, from around -0.80% a month earlier, according to RepoFunds Rate data. .
By Friday’s close, the repo rate had fallen to -0.85%, the data showed.
“We’ve seen some easing in the scarcity in the repo market, so rates are rising again,” said Rene Albrecht, strategist at DZ Bank.
Market participants said the latest squeeze was driven by exceptional demand for trades requiring specific bonds – dubbed “specials” – where rates fell below -1%, according to the RepoFunds Rates Index – against a rate around -0.6% on general warranty transactions.
“While special bond trading is a normal occurrence in the repo market, it has been seen more recently due to the market’s short positioning to take directional risk,” said Kate Karimson, head of European repo at BrokerTec.
German repo rateshttps://tmsnrt.rs/3541QLI
(Reporting by Yoruk Bahceli Editing by Sujata Rao, Emelia Sithole-Matarise and Mark Potter)
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