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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.
Capabilities
Media type
Themes
Figure 2: Change in swap rates over the next quarter
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.
The funding ratio index published by the Pension Protection Fund showed a slight decrease in funding levels quarter-on-quarter (124.7% at end March vs 125.7% at end December). Higher yields benefitted the liability side of the equation, however the dramatic fall in equities weighed upon funding ratios. High hedging levels mean that schemes saw only a modest gain from the higher yields but still retain some exposure to equities.
Market Outlook
Source: Columbia Threadneedle Investments. As at 31 March 2025
Inflation hedging rose by 12% quarter on quarter, whilst interest rate hedging activity increased by 27% from the previous quarter.
All data and sources Columbia Threadneedle Management Limited, as at 30 June 2024 and Valid to: 30 September 2024
Regions
The impact of the Iran conflict has put pressure on inflation expectations in the Eurozone, prompting decisive action by the European Central Bank to adjust their Bank Rate to respond to and manage price pressures and supply chain disruptions. This action was widely signposted and thus expected by markets, with a further hike anticipated in October.
2026 started on a positive note, with greater expectations of stability in French politics (at least for the time being) and with the focus firmly on an expansion of defence spending and capability to protect against Russian incursions. However, plans were thrown into disarray with the launch of the joint US-Israel conflict against Iran (and its proxies). With the key shipping route of the Strait of Hormuz closed for multiple months, stress fractures appeared in Europe; whether that be depleted stockpiles of oil/gas or concerns about manufacturing and farming inputs such as fertiliser and hydrogen. Europe faces a unique challenge of maintaining a common monetary policy over a country grouping with significant regional disparities. Whilst the cause in terms of energy pressures is common across the Euro area, the economic impact will be materially different based on individual fiscal trajectories and how much effective and immediate support individual countries are able to provide to cushion domestic industries. Quantitative easing – a generous Eurozone-wide support function – is no longer on the table (unlike during the 2022 oil shock) and therefore the burden will fall upon the balance sheet of each country. Indeed, European governments have contributed more than EUR11bn to support and protect against the energy price rises through such mediums as reducing fuel taxes. Yet, despite this, energy prices have continued to rise, and household inflation expectations remain elevated. Therefore, in June the European Central Bank took the plunge and raised the base rate from 2% to 2.25%, recognising that inflation expectations risked becoming ‘baked in’ and no longer transitory.
In markets, the popular ‘steepener’ trade (i.e. where longer dated yields are predicted to increase relative to shorter dated yields) was destroyed by the impact of the Iran conflict. Swiftly rising base rate expectations mechanistically flattened the curve, with short end rates rising relative to longer dated. As this played out with no certainty of an end in sight, market participants closed the position, often with a material loss. However, with the first rate-hike realised, and a hope that the Iran conflict may be soon resolved with a reopening of the Strait of Hormuz, eyes will turn back to the steepener trade. Part of the reason it was so crowded was that the underlying rationales have not gone away – fiscal stress and ageing populations, Dutch pension fund reform and global steepening pressures.
To return to the seemingly age-old topic of Dutch Pension Reform, or WTP, the next edition promises to be extremely interesting. The cohort of funds due to transition on 1st January 2027 are meaningfully larger than those of the 2026 grouping, but with some unusual characteristics. The first is that the transition is dominated by a single large fund which represents over 50% of the assets to be transferred on that date – their actions will be the foundation of the activity, whether they pre-position or tranche their hedging requirements. Secondly there are several smaller funds who appear at current viewing to be less well prepared for the upcoming changes. This may be a reflection o the 2026 cohort causing barely a ripple in the market, or there may be other factors at play, not least the complexity of establishing future hedging requirements in a rapidly changing asset return environment. (As a reminder, the hedging requirements under the new pensions system respond to market movements in rates and equities i.e., the asset mix of the portfolios). Given the focus on geopolitical considerations, it may be that this element has been de-prioritised. However, on the hope that a resolution to the conflict is soon to come, it is likely that these issues will once again come to the fore and we must consider the market landscape. The steepener trade as previously discussed was prevalent in the hedge fund community – such that they were able to absorb the risk transfer that took place at the start of the year. Currently, that positioning does not exist, so any similar scope of risk transfer would not have the same ability to be absorbed by the market. For those planning to transition in 2027 it would be prudent to maintain an eye on the developments in this space.
Market Outlook
Euro Government Debt
Since the downgrade of France and Belgium, considerations about whether to include or how to approach government allocations have abounded. Traditional AAA/AA indices used to be comprised of c. 41% France and 9% Belgium. The removal of these two issuers has put pressure on the other Governments that remain within the index, roughly doubling their concentration in the index: for example, Germany has increased from c.32% to c.63%. This trend, and the popularity of index investing, has increased the expense of investing in these Governments, whilst punishing those who are forced to switch out of higher yielding France or Belgium into higher rated (but lower yielding) sovereigns.
Now that the downgrade has occurred, we asked out counterparties for their views on whether France could now outperform Germany. Fully 75% believed in further underperformance for France, mainly predicated on the re-emergence of political risk at the end of the year with budgetary stress and of course the Presidential Elections in April 2027. In addition, the impact of the Iran conflict has put further pressure on the fiscal situation in France. This contrasts with the well-flagged expansion of debt in Germany to support defence ambitions. The counter argument is that France offers an attractive buying opportunity in a world of compressed spreads and as such could respond well in a risk-on environment assuming a swift resolution to the geopolitical issues.
EMIR 3.0 Regulatory Requirements
As we approach the first deadline for regulatory compliance of the new EMIR 3.0 requirements, it is worth reflecting upon the outcome. As a reminder, the key facet of this regulation is to promote stability in Euro assets via driving more central clearing of Euro-denominated swaps into the Eurozone. For market participants with an outstanding gross notional of over EUR 3bn there is a necessity to open an account at Eurex and post initial and variation margin – the so-called Active Account Requirement (AAR). There are additional reporting requirements for those whose volumes are less than 85% in Eurex. There is a further obligation for larger participants – those with over EUR6bn of cleared Euro-denominated derivatives – to transact a minimum amount of swaps in various categories within Eurex. This is the most challenging aspect for a pension fund client, requiring them to trade outside of their usual needs purely to meet their regulatory obligation. This is known as the Representative Criteria. Given the drive to move more clearing activity into the Eurozone, we asked our counterparties how their exposure to Eurex has altered since EMIR 3.0 came into force.
On average, our counterparties see c. 20% of client activity directed through Eurex with c.70% remaining in LCH. The residual is in bilateral trading activity which as a route has remained roughly consistent with prior years. Whilst the change is relatively small, half of our counterparties reflect an increase in activity in Eurex, mainly driven by German and Belgium clients; whereas the other half have seen no change. Compliance with the EMIR 3.0 regulations can present a challenge to clients given the complexity of the requirements and the liquidity and transaction cost factors in trading activity. If you would like to learn more about how we can assist in this sphere, please contact your client director.
