Market for Funding Bonds in France Shows Crisis Is Way Off Georgia Hall and James Hirai
The shock from turmoil in French debt has yet to appear in the country's short-term funding market, signaling a broad credit crisis is off the cards for now. While the sharp selloff in France's sovereign bonds has raised contagion fears, behind the scenes traders see no signs of stress in the ability to get cash in the repo market. This indicates the financial system's plumbing is working, but also that conditions could worsen if cracks appear.
With six months until next year's pivotal presidential elections, hedge funds have been offloading bonds, exacerbating turbulence. Any deterioration in their ability to get repo funding to cover positions -- as seen during the pandemic -- would herald a much more serious situation.
Repo markets are where institutions borrow cash against government bonds to finance leveraged trades. They have grown in importance alongside hedge fund activity, making them a key stress indicator. France's central bank warned in a June financial stability report that rising non-bank participation, high leverage and concentration among a small number of firms were increasing systemic risks. A handful of major banks sit at the center of repo intermediation, and more funding is flowing to hedge funds running "highly leveraged arbitrage strategies." That structure could amplify stress, trigger "sharp price swings" and create "contagion channels" if liquidity dries up.
While there's been heightened French repo activity and a brief spike in repo rates, they have since calmed to around 12 basis points, only slightly above the three-month average. The selloff in bonds reflects fiscal risk over coming years. The real test would be if further credit rating downgrades took France below repo collateral thresholds, mechanically shrinking the pool of lenders and raising bond holding costs.
Source: Bloomberg Markets · Summarized by HeadlinesBriefing