Analysis-European Central Bank faces pressure to release bonds and avoid market squeeze Reuters

© Reuters. File photo: On December 3, 2015, the European Union (EU) flag flies in front of the European Central Bank (ECB) headquarters in Frankfurt, Germany. REUTERS/Ralph Orlowski/File Photo

Francesco Canepa

Frankfurt (Reuters)-The European Central Bank is facing pressure from bankers to lend more German government bonds to avoid market tightening, which will undermine some of its own stimulus measures.

As the safest debt in the region, German sovereign bonds are the lifeblood of European financial markets and the most coveted collateral for clearing house transactions.​​

But they are not enough to meet the 8.3 trillion euros (9.3 trillion US dollars) market demand for repurchase agreements or repurchase agreements, and investors exchange cash for bonds.

This is because since 2015, the European Central Bank-mainly through the German Bundesbank-has raised nearly a third of Germany’s public debt to support the euro zone economy and renewed it during the COVID-19 pandemic.

The European Central Bank has exhausted the market through its trillion-euro debt purchase program, reducing the number of bonds that can be borrowed in the repurchase market on traders’ balance sheets.

Data from Refinitiv Eikon shows that investors are currently paying an interest rate of 0.99% to borrow German bonds in the form of cash for two months, which means that the bond interest rate on the next Monday, December 31, is 7%. The cost of borrowing debt for two months two months ago was 0.6%.

Therefore, bankers call on the European Central Bank, especially the German Central Bank, to lend more bonds to avoid drought, which will cost them a heavy price and may even lead to some defaults.

Godfried Dewitz, senior adviser to the International Capital Market Association’s trade agency, said: “If a major bank or fund fails to meet its obligations to the central clearing counterparty, the CCP must place it in default, thereby triggering all other CCPs. Breach of contract.”

The irony for the European Central Bank is that the shortage of German bonds available for borrowing may cause the financing market to stagnate, make credit more expensive, and run counter to the central bank’s loose monetary policy.

The trading premium on German bonds is the highest swap premium since the peak of the pandemic, and the spread on corporate bonds has begun to widen twice, albeit from very tight levels.

Squeeze construction of German bonds: https://fingfx.thomsonreuters.com/gfx/mkt/jnpwexnoqpw/Squeeze%20building%20on%20German%20bonds.png

This may become a headache for the European Central Bank as it is weighing how to end its plan to fight the pandemic in December without disrupting financial markets.

“If I work for the European Central Bank, given my lack of available monetary policy leverage, I will ensure that the market does not get into trouble as much as possible,” said Peter Chatwell, a strategist at brokerage Mizuho.

This issue has been bubbling in the background for many years, but as investors worry about the decline in the issuance of German bonds around the end of the year and banks shrinking their balance sheets to meet regulatory requirements, investors are worried that German bonds will shrink. It broke out in a few days.

The European Central Bank doubled the number of bonds that can be borrowed by 19 central banks in the Eurozone from 75 billion euros last week to 150 billion euros.

But analysts say this does not solve the problem, because banks face restrictions on how many bonds can be borrowed.

This is a safeguard measure taken by the central bank to minimize the risks they take and to incentivize borrowers to turn to the market.

“Counterparty restrictions are the real problem,” fixed income strategist Giuseppe Maraffino (Giuseppe Maraffino) Barclays (LON:) said the investment bank.

“If we see more transaction failures, we think the Bundesbank and other Eurozone central banks can consider increasing the counterparty limit, at least

temporarily. ”

Even for the safest companies, credit is more expensive: https://fingfx.thomsonreuters.com/gfx/mkt/zgvomkgxwvd/Spreads%20widening%20even%20for%20safest%20borrowers.png

(1 USD = 0.8909 Euro)

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