The mystery of higher repo rates (it’s the supply, stupid)

Summary
       
• The relative rise in euro money market secured rates since 2023 is a story of supply. The supply of high-quality collateral issued in core Eurozone countries has been rising both on a gross basis – relative to Euro Area GDP – and on a net basis: when adjusting for ECB holdings and other holdings that are ‘frozen’. Demand for bank reserves remains low, hence the basically negligible increases in unsecured rates.
• For this report I have replicated a basket of collateral that I have dubbed the ‘core HQLA basket.’ The basket consists of Dutch, German and French central government securities; debt securities of certain agencies domiciled in these countries with sizeable outstanding issuance; Extreme High Quality Covered Bonds issued in these countries; and debt securities issued by several supranational entities, foremost of which is the European Union. It’s my take of the securities that one might find in the Eurex ECB HQLA basket.  The size of the basket, when adjusted for ECB QE holdings and other frozen holdings and expressed as a percentage of excess bank reserves, explains the spread between the Eurex General Collateral (GC) pooled rate and the ECB deposit rate since 2017.
• In the report I forecast the growth of the core HQLA basket, as well as bank reserves twelve months out. Using this data as the input for a simple model, I can forecast the spread between GC repo and the ECB deposit rate twelve months out. The model shows that in the next twelve months, the spread will narrow before basically disappearing altogether.
• I do not expect blow-outs of repo rates like we experienced in the US in 2019. ECB Quantitative Tightening is proceeding at a relatively slow pace, and at the aggregate level we will not reach a too low level of bank reserves. Furthermore, by narrowing the spread on main refinancing operations, and by allowing banks to borrow on lower quality collateral (as is normal in the Eurosystem framework), there will be no shortage of bank reserves. The shortage of bank reserves was the spark that triggered the US repo market blow-up.
• As always, any unexpected problems in the Eurozone secured market will be the result of politics, not ECB policies or collateral supply.