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Repo rates are expressed relative to SONIA, and the chart below displays the average repo rates that we have achieved over the past four quarters for three, six, nine and 12-month repos, shown as a spread to average SONIA levels at the time. The volatility and market uncertainty that resulted from the mini-Budget also weighed upon funding markets, particularly for shorter dated trades as can be seen from the achieved spreads below. Note that during the fourth quarter of 2022 no repos were traded with a 12m tenor so the chart reflects the previous quarter’s value.
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The secondary impact of the mini-Budget crisis centred around collateral and the velocity of movement; rather than a lack of balance sheet for repo funding (a la March 2020). Yet, the difficulties around collateral substitutions and settlements did in many cases prompt a review by individual banks’ credit officers, resulting in a temporary reduction or hiatus in repo balance sheet provision in some cases. Once these reviews were completed balance sheet availability opened up again – some with the addition of haircuts to provide additional protection to the bank. Of course, the momentous lack of certainty in the future path of interest rates also impacted the typical repo spread to SONIA as trading a fixed rate forced the banks to take a conservative view on where yields could reach.
Regions
Volumes of trade activity remained below average in the second quarter of 2023 partly as a consequence of the evolving regulatory framework for UK pension funds; in particular around the appropriate level of resilience and the responsibilities of trustees and managers.
As in prior quarters, the key focus and driver of markets were central bank activity and data releases. In the US and Europe, inflation has responded to monetary tightening, allowing their central banks leeway in their flight path resulting in slower rises to their official rates as they balance the risks of a recession against higher than desired inflation. Unfortunately, the same is not true of the UK. Stubborn inflation even in the core measure (which excludes volatile energy and food) sparked a surprise 0.5% hike in June by the Bank of England. The May release of inflation showed CPI at 8.7% (0.3% above expectations) and core inflation at 7.1% (vs 6.8% expected and the same for the previous release). This has led to a complete repricing of the terminal base rate, whilst concerns abound that monetary tightening may yet do little to impact supply-side inflation.
Six month SONIA rate
Source: Barclays Live, as at 30th June 2023
Repo rates are expressed relative to SONIA, and the chart below displays the average repo rates that we have achieved over the past four quarters for three, six, nine and 12-month repos, shown as a spread to average SONIA levels at the time. Despite the uncertainty as to the future path of interest rates and a consequent slight increase in the standard spread over SONIA, the use of ‘specials’ to repo and netting exposure led to decreases in the average spread to SONIA paid for funding in the second quarter.
Spread to SONIA
Source: Columbia Threadneedle Investments, as at 30th June 2023
Following the gilt crisis last year, we are seeing interest from clients in credit repo and appetite from some banks to support the same. Credit repo allows portfolios with directly held credit to raise cash to support hedging without selling their credit once their gilt positions are depleted. Pricing is highly bank and bond dependent and can be anything from 10-50bps more than the cost of a traditional gilt repo, rising to 65bps more in a crisis. This means that credit repo should be thought of as a short-term contingency solution rather than a long-term funding tool. However, it is a beneficial addition to the toolbox and something we are putting in place for relevant portfolios.
SONIA – Sterling Overnight Index Average
