FT: European repo market showing signs of strain

The Financial Times reports that last week’s jump in bond yields was caused by traders’ fears that the eurozone repurchase market, “the plumbing of the global financial system,” was coming under strain.

Last week the Swiss National Bank was reported to no longer be accepting Portuguese government bonds as repo collateral for cash loans. From the Financial Times:

Although the SNB issued a clarification saying it had never accepted Portuguese bonds as collateral, markets remain nervous over the state of the repo market, which provides the flow of money that is the lifeblood of the financial system.

Banks in Greece, Ireland, Portugal and Spain are known to be relying heavily on repo loans from the European Central Bank for funding, a sign that banking in Europe is still not functioning normally, the Financial Times said.

The decision last November by LCH.Clearnet, one of Europe’s biggest clearing houses, to increase margin payments for banks that wanted to use Irish bonds as collateral for (repo) loans was considered an important moment in the chain of events that led Dublin to turn to emergency bail-out loans. Tensions created by the eurozone debt crisis last month forced the European Central Bank to shelve plans for the next stage in its “exit strategy” to unwind the exceptional measures taken after the collapse of Lehman Brothers in late 2008.

As a result, the ECB continues to provide unlimited liquidity for periods of up to three months.

Alan Wilde, head of fixed income and currency at Baring Asset Management, says: “At some point, concerns about the ECB’s balance sheet may lead to a deeper crisis. There has to be a limit to the amount of loans the central bank can lend.”

Bond yields rise when prices fall.