E Scarcity And The Hoarding Of Bonds As Gold In Repo

Understanding how the repo market works has been covered by multiple online websites, including TalkMarkets, so there are a few repo centered websites listed towards the end of this article that would be helpful to readers interested in the subject. Most quotations below except the the discussion concerning the New York Federal Reserve Bank, come from a very helpful British repo educational website, Treasurers.org.

Repo is used by central banks, pension funds, sovereign wealth funds, money markets, insurance companies, banks, hedge funds, at bond auctions, in underwriting bonds, in secondary markets, etc. Before getting into basic issues with repo, we can see that bond yields trend lower in good times and bad, and bond demand in repo markets plays a big part in that demand.

The pressing question regarding the repo markets centers on collateral demand and scarcity. How much real and potential demand is there for sovereign bonds, used as collateral for all sorts of financial markets.

Hoarding of bonds in the repo markets may produce scarcity. It is not yet at the high level of scarcity that we could see in a financial crisis, if bond values weaken and/or bond demand for use as collateral picks up.

Sovereign bonds make up 2/3rds of the US repo markets, and that is 5 trillion dollars. Many times these deals are over collateralized due to risk, and so there is a possibility that the value of bonds used as collateral exceeds the 2/3rds estimate. There is no actual measurement of dollar value of these securities, but it could be developed in the future. Special bonds may receive fierce bidding due to their scarcity:

Market-makers and other dealers will use the repo market to borrow bonds that are in strong demand in the cash market (and therefore sometimes scarce) in order to fulfill delivery commitments on sales of those bonds in the cash market. One of the most common reasons for a bond to go special is when it becomes the cheapest-to-deliver in the futures market for that bond. Some futures sellers will have difficulty buying what they need to deliver to the futures clearing house. As failure to deliver to a clearing house would have serious consequences, these parties will be forced to borrow the bond in the repo market and they may have to bid aggressively to secure it.

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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