FINANCIAL MARKETS AND EUROZONE CRISIS

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1 FINANCIAL MARKETS AND EUROZONE CRISIS GENERAL OVERVIEW MARCELLO MINENNA

2 A SINGLE CURRENCY, A SINGLE CURVE Trend of the 10 year interest rates over the period Choice of countries participating in the Euro Introduction of Euro Entry of Greece into the Euro Greece Portugal Ireland Italy Spain France Germany 2

3 A SINGLE CURRENCY, A SINGLE CURVE 1,00 Correlation between economic cycles of Germany and eurozone countries Period ,80 0,60 0,40 0,20 0,00 0,

4 A SINGLE CURRENCY, A SINGLE CURVE Correlation between regional and aggregate (national or UE) employment growth ,8 0,6 0,4 0,2 0 0,2 0,4 0,6 0,8 Provence Provenza (France) (Francia) Bavaria Baviera (Germany) (Germania) Lombardy Lombardia (Italy) (Italia) Catalonia Catalogna (Spain) (Spagna) Nazionale National UE 4

5 A SINGLE CURRENCY, A SINGLE CURVE Correlation between regional and aggregate (national or UE) employment growth ,9 0,8 0,7 0,6 0,5 0,4 0,3 0,2 0,1 0 Provence Provenza (France) (Francia) Bavaria Baviera (Germany) (Germania) Lombardy Lombardia (Italy) (Italia) Catalonia Catalogna (Spain) (Spagna) Nazionale National UE 5

6 A SINGLE CURRENCY, A SINGLE CURVE CONVERGENCE TRADE STRATEGY January 1996 Italy issues 2 years BTP with an 8% yield issue price 100 Germany issues 2 years BUND with a 2,5% yield issue price 100 January 1998 Italy issues 2 years BTP with a 5% yield issue price 100 Germany issues 2 years BUND with a 2,7% yield issue price 100 Forward purchase 2 years BTP 8% Forward sell 2 years BUND 2,5% Recieve 2 years BTP 8% Sell 2 years BTP 8% (+106 ) Buy 2 years BUND 2,5% ( 99 ) Deliver 2 years BUND 2,5% Net cashflows = 0 Net cashflows = + 7 6

7 A SINGLE CURRENCY, A SINGLE CURVE Collateral Discrimination before the crisis ( ) REPO MARKET SIDE ECB Banks give government bonds as collateral on repo market to obtain loans ECB SIDE Banks Banks provide funding Banks AAA A- BBB+ BBB- The ECB accepts all eurozone bonds at 100% of face value The ECB applies the same 5% haircut on all securities in the Eurozone below A The interbank market applies the same haircut All EU sovereign bonds are considered investment grade (above the BBB) and therefore NOT DISCRIMINATED

8 IMPLICATIONS OF THE FUNCTIONING OF THE EUROPEAN FINANCIAL SYSTEM Public Debt disintermediation by the retail investors Bank issued bonds held by households Obbligazioni bancarie in mano alle famiglie Sovereign bonds held by households Titoli di Stato in mano alle famiglie /12/ /06/ /12/ /06/ /12/ /06/ /12/ /06/ /12/ /06/2011 8

9 Average inflation in the Euro countries ,0% 3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% 9 Germany Austria Finland France Belgium Italy Luxembourg Nederland Spain Portugal Greece Ireland IMPLICATIONS OF THE FUNCTIONING OF THE EUROPEAN FINANCIAL SYSTEM

10 IMPLICATIONS OF THE FUNCTIONING OF THE EUROPEAN FINANCIAL SYSTEM Real foreign exchange rate in the Eurozone in the pre crisis period ( ) 15% 10% 5% 0% 5% 10% 15% Germania Austria Francia Finlandia Belgio Irlanda Italia Spagna Grecia Olanda Portogallo Germany Austria France Finland Belgium Ireland Italy Spain Greece Nederland Portugal 10

11 IMPLICATIONS OF THE FUNCTIONING OF THE EUROPEAN FINANCIAL SYSTEM Percentage of Sovereign Debt held by foreign investors 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Germania Francia Italia Spagna Grecia Portogallo Irlanda Germany France Italy Spain Greece Portugal Ireland

12 BEGINNING OF THE CRISIS Collateral Discrimination during the crisis REPO MARKET SIDE ECB Banks give government bonds as collateral on repo market to obtain loans ECB SIDE Banks Banks provide funding Banks AAA A- BBB+ BBB- ECB applies different haircuts on government bonds depending on rating and maturity e.g. haircut on fixed coupon: Rating Maturity AAA / A 2,5% 4,0% BBB+ / BBB 7,5% 9,0% The interbank market applies different haircuts e.g. haircut on fixed coupon: Country Maturity Germania 1,25% 2,5% Spagna 3,5% 7,75% EU sovereign bonds are considered DIFFERENT and therefore DISCRIMINATED

13 BEGINNING OF THE CRISIS Percentage of Sovereign Debt held by foreign investors 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Germania Francia Italia Spagna Grecia Portogallo Irlanda Germany France Italy Spain Greece Portugal Ireland

14 BEGINNING OF THE CRISIS 100% Banks exposure on national debt % Titoli di stato nazionali sul totale dell'esposizione sovereign nell'attivo bancario % of homecountry bonds wrt total exposure on sovereign bond 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% PORTOGALLO Portugal ITALIA Italy SPAGNA Spain Greece GRECIA 14

15 BEGINNING OF THE CRISIS Trend of the 10 year interest rates over the period Choice of countries participating in the Euro Introduction of Euro Entry of Greece into the Euro Greek debt crisis explosion Greece Portugal Lehman Brothers Bankruptcy Ireland Italy Spain France Germany 15

16 BEGINNING OF THE CRISIS Total Finantial Activities/GDP Italy Italia Germany Germania Spagna Spain USA Portogallo Portugal Giappone Japan Danimarca Denmark France Francia Regno U.K Unito Nederland Olanda 16

17 BEGINNING OF THE CRISIS Lira/Mark Exchange rate Italian Lira/German Mark; Sovereign bond spread and Sovereign CDS spread Period Tasso Exchange di Cambio rate Lira/Marco Lira/Mark Govt Spread (BTP Bund) CDS Spread (IT DE) % CDS % BTP Bund

18 THE COLLATERAL DISCRIMINATION AS AN ACCELERATOR OF THE CRISIS Correlation between Countries and Banks: the Italian case INCREASE OF THE CORRELATION 18

19 THE COLLATERAL DISCRIMINATION AS AN ACCELERATOR OF THE CRISIS Amount of collateral available to the banking systems December

20 THE COLLATERAL DISCRIMINATION AS AN ACCELERATOR OF THE CRISIS Amount of collateral available to the banking systems VS aids granted by the ECB December Italia Spagna Irlanda Portogallo Grecia Titoli governativi Titoli non governativi Aiuti concessi dalla BCE Sovereign bonds Non Sovereign bonds Aids granted by ECB 20

21 Percentage utilization of financial assets as collateral on the repo markets by issuer s nazionality (june 2012) 25% 20% 15% 10% 5% 0% Germania Regno Unito Francia Italia Eurozona (altri) Spagna Belgio USA Danimarca Giappone Germany UK France Italy UE (others) Spain Belgium USA Denmark Japan 21

22 Spread BTP BUND /08/ /06/2012 Focus on Italy Trend of the BTP BUND Spread vs implied default probabilities 0,45 0,4 0,35 0,3 21/12/2011; first LTRO; PD: 29,87% 0,25 29/2/2012; second LTRO; 0,2 PD: 23,99% 0,15 0,1 0, /04/ /12/ /02/ /04/ /06/ /08/ /10/ /12/ /02/ /04/ /06/ /08/ /10/ /12/ /02/ /04/ /06/ /08/ /10/ /12/ /02/ /04/ /06/ /08/ /10/ /12/ /02/ /11/2011; Greece Referendum ; PD: 33,71% 3/1/2011; BCE increases interest rates; PD: 16,55% 3/1/2011; BCE collateral discrimination; PD: 13,07% 15/9/2008; Lehman Brothers Bankruptcy; PD: 5,63% 22

23 Focus on Italy Management of Italian public debt 31/12/09; Debt Stock Stock: debito: mld mld 31/12/10; Debt Stock Stock: debito: mld mld 31/12/11; Debt Stock Stock: debito: mld mld < >20 maturity Average monthly yield 7,0 6,5 6,0 5,5 5,0 4,5 4,0 3, Amount placed 3,0 gen mar mag lug set nov gen mar mag lug set nov gen mar mag lug set nov gen mar mag lug set nov gen mar mag lug Titoli Short a breve term (<1Y) scadenza (<1Y) Titoli Medium Long a medio lungo term (>1Y) Rendimento 10 y average medio yield10y

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