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Banks take big risks in government bonds

As volatility has grown in developed-world government bond markets, so liquidity between dealers periodically evaporates. Yet banks are still opening their balance sheets to favoured investors.

Banks that once ran large proprietary risk-trading positions linked to their rates customer business have become much more conservative. One head of rates admits that his bank once operated a rates and government bond business with a balance sheet close to $100 billion. Its balance sheet is now closer to $20 billion.

At a time when markets are highly volatile and some very large investors, with big volumes of funds under management, want to reposition their portfolios with large, strategic risk-transfer trades, government bond dealers are trying to accommodate this with far less balance-sheet capacity than in the past.

Dealers don’t want to admit openly that the quality of markets – size and tightness of spread – now varies widely, depending on who is asking. It is not the same for different investing clients and it is not the same for clients as it is for each other.

One says: “The days of doing €100 million on 0.5 basis points across the board are over. It’s still possible for some favoured clients to get mid-price on €100 million Germany, France or Netherlands, and sometimes for Italy and Spain. And there are still times when you can do €500 million of Germany.

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