Germany Suspects Bond Shortage Is Caused by Sanctioned Holders

(Bloomberg) -- The German government increased the supply of hard-to-source bonds that it believes are being held by institutions sanctioned because of Russia's invasion of Ukraine.

“We have reason to believe that some of the securities are held by institutions that have been excluded from trading because of the current crisis,” a finance agency spokeswoman said by email, without identifying the entities or their host country. “Today's increase in the Federal Treasury note is our reaction to that in the interest of the market.”

The nation's finance agency will increase the volume of the 0% Federal Treasury note maturing in March 2024 to 8.5 billion euros ($9.4 billion), with the additional volume used exclusively for short-term repo and securities lending, according to an earlier statement. The reopening will be made to the federal government's own holdings with effect from Thursday.

The move comes after sanctions against Russia, which included freezing about half of its central bank's reserves. The rush for the safest assets as Russia escalated its invasion of Ukraine exacerbated global distortions in repo markets, where big market players swap securities for cash -- a crucial component of global liquidity that helps ensure the wheels of finance turn smoothly.

More Expensive

The repercussions for bond markets from the freezing of Russian assets have yet to fully unfold. Research by Commerzbank AG strategists estimates Russia's central bank holds about 60 billion euros in Japanese bonds, 50 billion euros each in German and French bonds, and another 25 billion euros in supranational debt from issuers such as the European Union.

“While this is not enough to affect the market as a whole, it can lead to dislocations in specific bonds,” said Christoph Rieger, head of fixed-rate strategy. The 2024 German bond “has been squeezed massively to repo levels below minus 5%,” he added, indicating that it is extremely expensive to borrow.

It is ambiguous what the impact will be on repo agreements carried before the sanctions hit, Rieger said. “It is unclear whether the bonds and cash can be returned, raising the risk that collateral needs to be sold,” he added.

Years of quantitative easing have reduced supply of high-quality bonds, which are systemically important assets owing to their use as collateral and to satisfy financial regulations. But in recent trading sessions, it has grown both more expensive and difficult to get a hold of them. Bund investors have been paying the highest premium since the euro-zone sovereign debt crisis to own cash bonds over equivalent swaps.

Developed-market government bonds are used as collateral to underpin repurchase agreements -- short-term secured loans -- thanks to their liquidity and creditworthiness. The likes of hedge funds engage in repo activity to fund their leveraged trades and to borrow securities in order to take short positions.

Much of the logjam in the collateral supply-chain is centered around particularly scarce bonds. Germany's finance agency noted this was an “exceptional situation” given the “delivery difficulties that currently arise” in the security.

“We are in a collateral squeeze,” said Althea Spinozzi, fixed-income strategist at Saxo Bank, who says the freezing of Russian assets might be contributing to repo distortions alongside investors flocking to haven assets. “The market has to reset to reflect the sudden drop in tangible assets.”