ECB Repo Plan May Make Negative Bund Yields a Matter of Time

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The European Central Bank’s efforts to keep the region’s debt markets from drying up may be acting as a magnet for lower yields on government bonds.

Introduced earlier this month, the ECB’s securities-lending program allows banks to temporarily exchange bonds they own for those the central bank has bought under its quantitative-easing policy. The plan is designed to ensure the purchases of 60 billion euros ($66 billion) of debt a month don’t hurt market liquidity by preventing participants from getting hold of specific securities they may need.

So far, it has done little to ease signs of a scarcening availability of government bonds, particularly higher-rated debt that’s most frequently used for collateral. Repurchase rates in the euro area have fallen below zero, meaning traders are paying another entity to take their cash so that they can own the securities for a limited period.

The ECB’s fee of 40 basis points to lend highly valued securities isn’t seen filling the gap because it’s more than double the current cost of borrowing securities in the German repo market.

That fee may actually help to suck general collateral rates further below zero, increasing demand for bonds in the cash market, according to Peter Chatwell, a fixed-income strategist at Mizuho International Plc in London. He says it’s only a matter of time before German 10-year bunds start trading with negative yields.

“It’s a matter of when, not if” bund yields will reach zero, Chatwell said. “You only really want to go and borrow something at 40 basis points if market repo gets more expensive than that and at the moment I don’t see anything more expensive. The program will just be sitting there to act as a floor on repo rates in the market.”

Repo Agreements

The euro area’s 5.5 trillion-euro repurchase market is typically used for short-term funding, with debt provided as collateral for loans. It’s also used by traders to obtain securities that they need and don’t currently own.

The repo market’s negative rates indicate stronger demand for bonds, which can be because banks that act as primary dealers need them to offer for sale to customers, or because financial institutions need the higher-rated debt for regulatory purposes.

Graded AAA with ratings companies, and having the most liquid euro-area market, German bonds are in particular demand. They also make up the largest part of ECB purchases, meaning the central bank faces competition to buy them.

Negative Yields

The benchmark 10-year yield has tumbled 38 basis points this year, to 0.16 percent at 4 p.m. London time Tuesday, after the ECB started its 1.1 trillion-euro stimulus program last month. The bund yield fell to a record-low 0.049 percent on April 17.

Sixty-seven percent of the $1.16 trillion of debt in the Bloomberg Germany Sovereign Bond Index, with a market value of $774 billion, has yields below zero. That means buyers of the notes would get back less than they paid if they held the securities until they came due.

The RepoFunds Rate for Germany, an index of the effective cost of funding, was at minus 0.189 percent on Monday, according to data from ICAP Plc. The rate will keep falling and repo rates for longer maturities will become negative as demand for high-quality debt increases, said John Edwards, managing director for Europe, the Middle East and Africa at ICAP’s BrokerTec business.

‘Quality Collateral’

“This really demonstrates the huge demand and appetite for quality collateral for capital purposes from the major financial institutions,” Edwards said. “They are comfortable buying or borrowing a bond and having to pay to hold that security.”

Amid heightened demand for a specific security it can trade “special,” meaning it is particularly expensive to get hold of those bonds compared with the general collateral rate.

“There is a degree of specialness in certain parts of the bund curve,” Chatwell said. “This doesn’t appear to have eased” since securities-lending started, he said. “In an environment where no one is really scared about the market turning around, there are still reasons to be long on the German curve.”

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