By Francesco Canepa

FRANKFURT (Reuters). Bankers pressure the European Central Bank to borrow more German government bond to prevent a market collapse that could undo its previous stimulus efforts.

Germany’s sovereign bond is the strongest debt in the area and the most sought-after collateral to guarantee trades at clearinghouses.

However, there isn’t enough to meet the demand for 8.3 Trillion Euros ($9.3 Trillion) repurchase agreements. These are where investors trade cash for bonds.

The reason is that the ECB, mostly through Germany’s Bundesbank, has accumulated almost a third German public debt to help support the euro area economy. This was done in 2015, and again during the COVID-19 pandemic.

The ECB’s multi-trillion-euro debt buying programmes have drained markets. There are now fewer bonds left on dealers balance sheets, and they can be borrowed on repo.

Current rates for borrowing German bonds from cash are 0.99%. That’s 7% for loans made on Monday Dec. 31, according to Refinitiv Eikon data. The cost of borrowing for two months was 0.6% in February.

The bankers are urging the ECB and especially the Bundesbank to loan more bonds in order to avert a severe drought. This would be costly and could even lead to default.

Godfried De Vidts (a senior advisor for the International Capital Market Association) stated that “if a major fund or bank cannot fulfill its obligation toward a counterpart in central clearing, the CCP must place them in default, which triggers defaults on all other CCPs.”

Ironically, for the ECB the lack of German bond available for borrowing risks causing financing markets to become sluggish, which could make credit more expensive, going against the spirit and intent of the central banks’ easy-money policy.

German bonds are trading at the highest premium to swaps ever since the peak of the pandemic. Spreads on corporate bonds started to widen but from extremely tight levels.

Squeeze building in German bonds: https://fingfx.thomsonreuters.com/gfx/mkt/jnpwexnoqpw/Squeeze%20building%20on%20German%20bonds.png

The ECB could find itself in a difficult situation as it tries to decide how to end its pandemic-fighting program in December without causing financial market disruption.

Peter Chatwell, a broker strategist, stated that “if I was working for the ECB and there were no monetary policy levers to me, I would make sure the market wasn’t as distressed”

Although the issue was bubbling for many years, it is now thriving due to investor concerns about a German bond pinch at year’s end when issuance falls. Banks shrink their balances in order to comply with regulatory requirements.

The ECB has doubled the number of bonds the central banks in the Euro zone can borrow against cash, from 75 billion to 150 billion euro last week.

Analysts disagree, pointing out that banks face a limitation on how many bonds can be borrowed.

It is an insurance policy that central banks use to reduce risk and incentivize borrowers to go to the markets.

Giuseppe Maraffino, fixed income strategist and fixed income expert at Giuseppe Maraffino said that “the counterparty limit” is the main problem. Barclays Investment Bank.

“If there were more transaction failures, we believe the Bundesbank could and should consider increasing the counterparty limit.

temporarily.”

Credit is more expensive even for the safest companies: https://fingfx.thomsonreuters.com/gfx/mkt/zgvomkgxwvd/Spreads%20widening%20even%20for%20safest%20borrowers.png

($1 = 0.8909 euros)