A debt metric is flashing warnings about Europe’s dwindling pool of bond collateral, bucking broader optimism in the market.
(Bloomberg) — A debt metric is flashing warnings about Europe’s dwindling pool of bond collateral, bucking broader optimism in the market.
The European Central Bank’s move to discourage national governments from parking funds on its deposits has raised the cash in circulation and sent it hunting safer assets with comparatively high returns. As a result, banks are buying up German two-year notes, along with other top-rated debt, reducing the overall volume of quality collateral.
That’s warping the role of Germany’s two-year asset swap spread as a traditional measure of risk — pushing it toward a year-to-date high and breaking its once-close relationship with a key measure of volatility.
“The wide spreads are currently more a reflection of returning collateral scarcity concerns,” wrote Benjamin Schroeder, a strategist at ING Groep NV, citing the ECB’s decision to remunerate government deposits at a less-attractive rate since the start of the month.
The change has raised the sum of spare cash in the economy by around €130 billion ($140.6 billion).
The growing bond shortage is also showing up in repo markets, according to Michael Leister, Commerzbank AG’s head of rates strategy. His analysis of 10 bonds that are subject to exceptional demand shows their premium over the ECB’s overnight rate has climbed to above 40 basis points for the first time this year.
To be sure, Leister says the German Finance Agency will pursue “steady collateral supply rather than scarcity,” which should eventually rein in the premium currently embedded in swap spreads.
Leister holds a tactically cautious stance on two-year swap spreads, but recommends positioning for a move tighter should the premium widen above 90 basis points from the current 81.
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