Owain Johnson, CME Group
AT A GLANCE
- Euro repo volumes soared in May as traders shifted their risk positioning, despite little change in short-dated financing levels.
- Despite elevated levels of activity in the European repo market, rates have remained steady, perhaps due to a lack of short-term central bank activity.
Firms have turned to the European repo market amid an increase in volatility in the financial markets, which has encouraged participants to review their approach to risk.
Europe and the U.S. both experienced heightened volatility in both equities and bonds during May. Concern about increased inflation and the impact of any resultant central bank activity was by far the most significant driver of volatility, though the dramatic decline in prices for cryptocurrencies seen in late May was another major driver of volatility.
Perhaps the key debate in the market was whether central banks are correct in their assumption that heightened inflation rates will be limited as largely a consequence of the recovery from the pandemic, with inflation levels swiftly returning to normal.
Some participants on CME’s BrokerTec platform, which handles the majority of European repo activity, are responding to the current situation by seeking to add more directional risk as they express their view of likely developments. This increased trading activity needs to be financed, and so these firms are making use of the repo market to raise those funds.
At the same time, other market participants have exited positions in the equity or crypto markets. Some of the capital that has been withdrawn from those markets found its way into the repo market, as firms look to put their money to work until they are ready to reinvest in other assets.
The increased volatility in the marketplace also raises concerns around credit performance, and so entities seeking financing and funding continue to prefer secured Repo trading.
This increased use of European repo led the BrokerTec platform to post some significant milestones in May 2021. Average daily volume for European repo was up 14% YoY, while the month of May contained 12 of the 20 most active days ever seen for European repo.
That strong month contributed to a very positive start to 2021, with the first five months of 2021 seeing European repo up 10% compared with the previous year. This year has already included 18 of the most active 20 days ever seen in European repo, even before reaching the halfway mark of 2021.
Despite the elevated levels of activity, it is notable that European repo rates have remained very steady. May saw virtually no change in short-dated funding levels, despite the large number of highly active trading sessions.
The steady levels were perhaps a result of the lack of short-term activity from the central banks. The Bank of England held its monetary policy meeting on May 6, and as was widely expected, voted to keep both the base rate at 0.10% and their Gilt purchase target at £875 billion.
The European Central Bank (ECB) did not hold a scheduled monetary policy meeting in May; their next meeting was held on the June 10 when they left rates unchanged. Few market observers expect the ECB to make any changes in rates for another year or so.