Coronavirus leads to European repo activity uptick

Coronavirus leads to European repo activity uptick

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By Owain Johnson, CME Group's head of research

The impact of the coronavirus outbreak on Chinese demand for raw materials has already made itself felt in the commodity futures markets, pulling key industrial inputs oil and copper down 21% and 9% respectively between 6 January – the last day before reports of the virus reached the international media – and 4 February.

As concerns about the impact of the virus on the broader global economy continue to grow, the second-order effects are being felt in disparate markets across the world, even those that might at first glance seem to be removed from the epicentre in Wuhan.

Cash looking for a home

European repo activity on CME’s BrokerTec platform saw a brief spike in early February as the severity of the coronavirus became clear. 

The negative impact of the virus outbreak and the efforts to contain its spread on the Chinese economy led to a major sell-off of equities in markets around the world in late January.  This withdrawal of investment from equities left many firms holding more cash than would be typical in normal trading conditions, leading some of them to turn to the repo market as a home for these larger-than-normal cash holdings.

The next working day after the major sell off in equities on 31 January, when the S&P 500 Index fell 1.8% day-on-day to 3,225.52, BrokerTec recorded its busiest day of the year as participants made use of the European repo market to place proceeds from equity liquidations whilst pondering future investment strategy decisions.

The correlation between the performance of the equity markets, which has been driven in recent weeks by the news from China, and European repo activity is noticeable.  The announcement on 2 February by the Chinese government of a major stimulus package intended to boost economic activity levels sent equity markets back to their pre-virus levels and saw BrokerTec’s European repo business return to more typical volumes.

US exceptionalism

Although the links between the spread of the coronavirus, equity prices and European repo have been strong, the still larger U.S. repo markets have not experienced the same phenomenon.  This is likely because, although the U.S. has experienced the same pattern of equity sell offs and recovery in early February, the market is more focused on the activities of the U.S. Federal Reserve.

The Fed introduced significant ‘repo operations’ in the wake of the repo funding issues experienced in September and has since become the major supplier of liquidity to the U.S. repo markets, dampening multilateral repo activity and limiting the impact on the U.S. repo market of external factors like the coronavirus.

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