Asset Swap Spreads Continue To Tighten, Eyeing TLTROs (1/3)

Unwinding TLTROs - starting with this week's early repayment window - is a key to shrinking the size of the ECB balance sheet while also better calibrating monetary policy transmission. But also, earlier repayments are seen reducing collateral scarcity, a key theme in repo / swaps markets in recent months.

• Several factors have helped narrow swap spreads in the past 6 weeks:
  • the ECB's unexpected announcement last week that it would increase the limit on securities lending vs cash, with a clear eye on potential year-end tensions
  • the German debt agency's decision in October to increase bonds available for repo
  • the general risk asset rally, which has seen risk premia narrow more generally from October's peak (see chart of ASW Schatz which has fallen 40bp; vs 10Y BTP spreads and inverted Eurostoxx futures).
• The TLTRO announcement Friday could be a (marginal) driver as well. If banks make huge early repayments, it could free up some collateral in the markets and keep spreads tightening.
• But that said, the impact is expected to be limited (a topic touched on in MNI's interview w the ICMA's Andy Hill): freed-up collateral that had been posted by banks in TLTRO operations may not be of the "higher quality" variety (ie German bonds) required to make a significant difference in narrowing ASW spreads.

Schatz ASW Spread vs Eurozone Equities (Inverted), BTP/Bund SpreadSource: BBG, MNI