Analysis-Investors face a costly quest for cash and safe assets at year-end

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© Reuters. FILE PHOTO: A trader works at the Frankfurt Stock Exchange in Frankfurt, Germany February 22, 2022. REUTERS/Timm Reichert

By Yoruk Bahceli (Reuters) – As the most volatile period for traders in years draws to a close, the year-end race for cash and high-quality assets is likely to prove more difficult than ever. usual in markets rocked by decades-long high inflation and aggressive central bank rate hikes. The approach to year-end typically sees strong demand to place or obtain cash as financial institutions seek to strengthen their balance sheets, rebalance their portfolios and transfer funds to close out the year. But this year, with US market volatility gauges back to levels seen at the height of the COVID-19 pandemic and an uncertain economic outlook, it’s harder than normal for banks to take risk on their balance sheets. . Money markets also suggest that securing the cash and quality assets investors need to make a smooth transition to 2023 will be expensive. “When you look at all three quarters end this year and compare them to previous years, each one was significantly more expensive than in the past,” said Michael Leister, head of interest rate strategy at Commerzbank (ETR :). GRAPHIC: 2022 quarter-end repo rates are historically high (https://graphics.Reuters.com/GLOBAL-MARKETS/jnpwyegyqpw/chart.png) German repurchase agreements – where investors borrow collateral, typically government bonds, in exchange for cash – have implied rates of around minus 10% for the end of the year, the International Capital Market Association said in a letter at the end of October calling on the European Central Bank to act. These deeply negative repo rates, which compare to minus 4.5% as of December 31 last year according to CME Group (NASDAQ:), reflect the high cost of borrowing German bonds amid a shortage of collateral is plaguing eurozone bond markets. The ECB’s bond purchases left a tiny fraction of German debt available for asset managers. The head of Germany’s debt agency, Tammo Diemer, said last month that year-end forward repo rates were showing strong demand as early as August, due to investors posting record levels of guarantees in clearing houses against potential losses. A similar collateral shortage in Britain is keeping repo rates well below the 3% key rate and could lead the Bank of England to intervene, according to NatWest (LON:) Markets. In the United States, the premium on year-end interbank borrowing, measured by the difference between the so-called FRA-OIS spreads for December and March, was much higher throughout the year than the average levels observed over the past five years, BofA noted in October. CHART: FRA-OIS premium for December versus March (https://fingfx.thomsonreuters.com/gfx/mkt/gdvzqyrqrpw/bofa%20fra%20ois.png) In currency swaps, where investors trade euros, yen and Swiss francs for US dollars, the relative premium to get dollars widened to the highest since the peak of the COVID-19 pandemic in March 2020 to the end of September, when they began to take into account the end of the year. This premium is rising sharply each year through the end of September, but the magnitude of this year’s move in the euro-dollar swap was the largest since 2008, according to data from ICAP (LON:). “It’s a sign that the demand for dollar financing at the end of the year is really strong and probably stronger than in previous years, at least compared to the market’s ability to meet this demand,” said Antoine Bouvet. , Senior Rates Strategist at ING. The premium fell sharply, also after surprise U.S. inflation data on Thursday prompted a rethink of bets on the Federal Reserve’s rate hike. But analysts noted that the end of the year is still a month and a half away and that the gap tends to widen in late November as demand for cash increases. The risk is all unexpected news as liquidity dwindles further in December, forcing investors to reconsider their positioning. “You have to be more careful about positioning to carry over into the new year, even more so than in previous years,” said Dalibor Jarnevic, head of government bond trading at DZ Bank. Jarnevic noted that the December 15 ECB meeting, a day after the Fed, poses a particular risk if it surprises markets. “Normally until then…the investor base has already done its basic positioning through to the end of the year and trading volumes already tend to be very low,” he said. declared. “It could cause people to accept prices that they are not used to in the government market.” WATCH September’s UK fiscal turmoil highlighted how a shock event occurring when liquidity is already low can destabilize a market. Policy makers are aware of the risks. The German debt agency recently increased its own bonds by 54 billion euros to lend to investors in the repo market. The ECB on Thursday increased the bonds it lends against cash by 100 billion euros. Analysts said the moves would ease year-end pressure, but noted potential constraints. The end of 2021 still saw significant pressure even after the intervention of the two institutions.
BofA said it now saw the German year-end repo 6 percentage points below the overnight rate, which it said would still make it the most expensive on record for investors borrowing bonds. at the time. The overnight rate is currently at 1.4%. “It’s still early days, but (last year’s repo price) would probably already be the best case in terms of year-end pricing,” Commerzbank’s Leister said.

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