Germany's bond shortage is finally easing

For the better part of seven years, the European sovereign repo market was haunted by an artificial pathology: an acute scarcity of German Bunds. The European Central Bank’s quantitative easing apparatus had vacuumed up hundreds of billions of high-quality sovereign collateral, leaving commercial banks and hedge funds with insufficient high-grade paper to clear repo transactions. At the height of the collateral squeeze in 2022, two-year Bund swap spreads blew out toward 100 basis points as market participants paid exorbitant premia to borrow physical German paper. As 2023 begins, however, that collateral famine is finally showing signs of structural relief.

The easing of the Bund shortage is driven by a convergence of fiscal and monetary reversals. First, the German federal government has dramatically expanded its sovereign issuance programme to fund massive domestic energy subsidies, injecting hundreds of billions in fresh paper directly into primary dealer pipelines.

Collateral Liberation

Second, the ECB has begun to dismantle its collateral hoarding policy. By increasing the limits on its securities lending facility and raising the remuneration rate on government cash deposits, Frankfurt has removed the mechanical incentive for sovereign treasuries to park cash at the central bank rather than in the private repo market.

Furthermore, the impending start of ECB quantitative tightening—phasing out the reinvestment of maturing APP bonds at a pace of €15 billion per month—guarantees a steady return of physical collateral to the private financial system.

Normalising Swap Spreads

The normalisation of European collateral markets is rapidly compressing Bund swap spreads back toward historical ranges. This adjustment restores the integrity of the euro benchmark curve, allowing corporate bond issuers and institutional hedgers to price interest rate risk without factoring in an artificial collateral premium.

It also restores balance to cross-currency basis markets, where European banks had previously faced steep hurdles in sourcing dollar liquidity against sovereign collateral. The liberation of German sovereign collateral marks a critical step toward post-QE market normalisation, removing an artificial distortion that crippled European money markets for nearly a decade.