The ECB learns a lesson on how to run a bond market

Tuesday saw a huge rush in the perceived safety of investment grade government bonds. The corresponding yield slump was most pronounced in Europe, with the German 10-year yield even turning negative again, sparked by Finnish central bank chief Olli Rehn’s comments that the ECB should wait to exit its bonds. recovery programs.

But a one-day drop of more than 20 basis points in the region’s debt benchmark yield is an extraordinary event, and such a violent move warrants a closer look at how easy it really is to trade. public titles. A well-functioning bond market is a prerequisite for financial stability. Instead, there was a massive shortage across Europe as primary traders desperately tried to hedge sales to global reserve managers who actively added high-quality collateral.

The lack of free-floating core European government bonds has long been a problem, but that is by design rather than by chance. The bloc’s central banks alone hold 3 trillion euros ($3.3 trillion) of the market following the quantitative easing program which has kept borrowing costs at rock bottom levels. But this risks depriving traders of liquidity. In February 2018, Benoit Coeure, then a member of the ECB’s executive board, estimated that the proportion available for trading in bunds was slightly above 10%. It is almost certainly even lower now that central banks around the world have cornered the best quality collateral for their reserves. The floats of the Dutch, French, Austrian, Finnish, Irish and Belgian markets are also relatively very low compared to global standards. And that can cause problems in times of stress such as the markets are currently experiencing.

On Thursday, Germany took the rare step of issuing new bonds two weeks ahead of a scheduled auction, selling 2.5 billion euros of the two-year 0% benchmark issue and increasing its size to 8.5 billion euros. He acted early in a bid to ease tensions in the buy-back market, where brokers who need to borrow specific bonds trade with long-term holders in exchange for a fee. Rising demand for German two-year bonds has heightened the risk of “failure,” where traders cannot get their hands on particular bonds to meet their commitments. In press releases, the Finance Agency referred to an “exceptional situation” caused by the fact that the securities are “held by institutions which have been excluded from trading”. The risk is that these shortages will become more common.

The Federal Reserve and Bank of England have long been more accommodating to their primary trading communities than their eurozone counterparts, offering a range of facilities to access in-demand bonds that have potential delivery issues to maintain the operation of the entire settlement process. gently. The Fed’s permanent repo facility is the latest addition to help eligible counterparties raise funds, but it also works in reverse when brokers need to borrow particular securities. The UK Central Bank, together with the Treasury’s Office of Debt Management, has a range of liquidity assurance facilities.

Fed Chairman Jerome Powell reiterated his new watchword to be “agile” this week during congressional hearings. This is a mantra that national central banks in Europe should adopt with regard to not only their purchases of government bonds but also their sales. The proper functioning of the financial system requires flexibility. It is good to see the German authorities adopting this. More please.

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This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in banking, most recently as Chief Market Strategist at Haitong Securities in London.

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