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Could someone please explain the carry and roll trade that a lot of traders are doing with negative euro debt?

I read an example that they borrow in the repo market then buy a longer dated bond to generate positive carry - but can someone please explain the repo part? They would have to own a short dated bond to be able to repo it to get financing to purchase the long dated bond right? If so, shouldn't the cost of purchasing the short dated bond be factored into the profit calculations?

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  • $\begingroup$ I’m no expert on the repo side, but suspect that it’s little more complicated than buying a Bobl, Bund or OAT future. There’s no “ownership” of a shorter-dated funding leg. There’s just a more negative funding cost than the running yield, and a steep curve to roll down. Might be wrong, but suspect this is the wheeze. $\endgroup$
    – demully
    Aug 21, 2019 at 22:28

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The transaction is basically just going into repo, borrowing cash and buying a long dated bond. Then using that bond and giving it to the repo desk as collateral. The repo is negative so you're being paid.

Secondly, you short a negative yielding short maturity bond by borrowing the bond from repo desk, selling it in the market for cash and lending that cash to the repo desk. In this transaction, you're selling a negative yielding bond at a price higher than par (at premium). Then you lend out cash, presumably at a negative rate meaning you will probably pay repo.

The repo legs should cancel out so you're left with the long on the long dated bond and the short on the short dated bond. The short leg rolls up the curve due to pull to par since it's negative yielding and your long leg should roll down.

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  • $\begingroup$ Thanks for your comment - I understood your first paragraph but got totally confused in the second paragraph. So I have my bond that I bought trough borrowing cash in repo? Why do I then need to go and short a negatively yielding short maturity bond? Also after I borrow the bond from the repo desk, I sell it for cash & lend that cash to the repo desk? How can I sell a bond that I am only borrowing? $\endgroup$
    – NewInvestor
    Sep 30, 2019 at 15:02
  • $\begingroup$ Thinking about it further - why would I even need to go back into the repo market to short a short maturity bond? If I buy a long dated bond using funding from the repo market, is that enough? I would be receiving the repo interest (b/c its negative) which would give me a positive carry? $\endgroup$
    – NewInvestor
    Sep 30, 2019 at 15:33
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If you buy a 30Y bond at (say) -0.1% via a repurchase agreement that pays (say) -1.0% then you will earn 0.9% per annum on a "carry" basis.

However, this might not be attractive for one of these reasons (amongst others):

  • You are implictly assuming a large amount of market risk. If interest rates fall you might lose substantially more on the capital than your "carry" brings in.
  • You do not have the balance sheet capacity to support the trade, i.e. the Basel capital requirements for holding such a liability and asset considerably mitigates the potential gain of 0.9%.
  • You have not accounted for any roll-down or adjusted bond price that mitigates any of this gain upon your eventual sale of the bond 1Y later.

On the flip side, if your view is that bond yields will fall this trade allows you to express that view with an element of carry embedded and potentially limited amounts of capital for investors, and so might have been quite popular amongst eur investors in the last few months, and particularly profitable.

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  • $\begingroup$ Thanks for comment - Just a quick one, how did you get 0.9% carry? What I am understanding is that I bought the bond for -1% and I funded the purchase through repo? If so, aren't I paying the bank/whoever the 1% so my "carry" would be -1.09? $\endgroup$
    – NewInvestor
    Sep 30, 2019 at 14:52

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