Merchants accumulating bonuses cause a strong compression of guarantees

Dealers and investors in Europe and the United States are racing to hoard the safest assets as collateral – – erasing the financial plumbing of the biggest bond markets with echoes of the disruptions created by the 2020 pandemic. Russia’s invasion of Ukraine spurred a disruptive flight to quality as Treasury traders neglected to follow through on their so-called buy-back deals to the max for about two years. Across the Atlantic, members of the UK market have been forced to repeatedly use a backup repo facility as short-term gilt liquidity dries up. Bund investors, meanwhile, paid the most remarkable premium since the eurozone sovereign debt crisis for holding cash bonds over equivalent swaps.

“As soon as things get choppy and bid-to-offer spreads widen, finding paper to hedge trades through the repo market is both more expensive and more difficult,” said strategist Marc Ostwald. worldwide at ADM Investor Services. “The fact that central banks have absorbed so much of the ‘float’ in the markets via quantitative easing clearly also plays a role.”

While there is no funding crisis, these are all market disruptions that are sapping liquidity and threatening to obstruct the flow of money for asset-to-asset transactions – particularly in Europe – as the hunt to high quality guarantees rages. The repo market, where large market participants exchange securities for cash, is a crucial part of global bond liquidity and helps keep the wheels of finance running smoothly.

Developed market government bonds are used as collateral to support repurchase agreements (short-term secured loans) due to their liquidity and creditworthiness. Hedge funds like hedge funds engage in repo activity to fund their leveraged transactions and to borrow securities to take short positions.

The so-called asset-swap spread of benchmark German bonds is the widest since the 2011 eurozone crisis, while the premium for holding cash bonds in the US is lower as demand refuge in the United States is more modest.

Today, as geopolitical tensions spur risk aversion and Russian asset trading freezes, many market participants face exorbitant costs to source the most sought-after financial instruments, especially in Europe.

In the United States, the overnight general collateral repurchase agreement rate traded above the yield offered by the Federal Reserve on its reverse repo facility – currently 0.05% – an indication that funding markets continue to function despite geopolitical turmoil.

It’s a somewhat different story in the UK. Dealers have flocked to a standing facility – whereby the Debt Management Office lends specific gilt for repurchase purposes – at the fastest pace since the early days of the pandemic.

Much of the stalemate in the collateral supply chain centers on particularly rare bonds. A gilt maturing in 2023 has proven difficult for gilt traders to find. The evolution of special rates compared to general guarantee rates in markets such as Germany implies “that there is an increased shortage of certain guarantees in the market”, said Kate Karimson, executive director of the platform. BrokerTec Fixed Income Trading. The shortage of collateral, a long-standing problem among investors, could ease if central banks reduce their assets, although the outlook for policy tightening looks less certain due to the fallout on Ukraine.

In the view of many participants, the sudden rush to own the safest assets after this year’s bond sell-off is exacerbating liquidity concerns. Investors bet against bonds on the prospect of monetary tightening, leaving some stocks subject to short-squeeze. There has been “increased pressure on specific bond levels, potentially due to market short positioning looking to take on directional risk,” said John Edwards, a colleague of Karimson at BrokerTec.

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  • Merchants accumulating bonuses cause a strong compression of guarantees
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