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CE Macro Report

There is increasing uncertainty for the fate of the EU in the case of Brexit. The Bank of England has stated that the referendum is “the most significant near-term domestic risk to financial stability”, and brings the risk of a credit crunch. As a result, they have toughened this year’s stress tests and will offer additional liquidity measures to banks in the weeks surrounding the vote. Undoubtedly the effects of a proBrexit result will be volatility, however, to what extent is impossible to say. Approximately 200m jobs in the eurozone depend on trade with Britain. These jobs and overall terms of trade between the EU and Britain would become uncertain in the case of a proBrexit result. Additionally, remaining contributors to the bloc’s budget would be obligated to make larger payments. Brexit could have additional effects by setting a precedent for exit from the union, as it would demonstrate for the first time that EU integration can be reversed. This is especially important at time when tensions in the EU are high because of recent terrorist attacks and the refugee crisis. A recent survey found that 53% of French voters want a referendum on their EU membership. Over the summer of 2015 there was the possibility of Grexit and many European countries have considered departure from the union as a politically viable solution to both economic and social challenges.

After 300 years of independence the London Stock Exchange is poised to merge with Deutsche Börse, creating one of the world’s largest exchange operators. Under the proposed deal, Deutsche Börse shareholders would own 54.4% of the combined group and LSE shareholders 45.6%. The merger is expected to improve efficiencies, generating an additional EUR 450m over 3 years. The deal’s scale effects offer banks and investors billions of savings in the costs of trading in OTC markets; this is especially relevant as new Basel regulations are implemented: banks are forced to post larger amounts of collateral at clearing houses and are subjected to a higher leverage ratio. The largest impact will be felt by the risk management business, as the exchange would net off extra products’ risk, reducing the amount of capital held against positions. One way this is done is through compression, where OTC trades that offset each other are torn up, cutting gross exposure levels. Moreover, the new system would enable banks better margin-netting opportunities, netting the margin that traders post to back both their future and swaps derivatives. Critics of the merger warn against the creation of an exchange that is too big to fail with monopolistic charges. The main argument cited is a loss of independence, however there are more British shareholders in Deutsche Börse then German and the two exchanges are undeniably linked already. A consideration going forward is the practical aspects of the merger.

The European Central Bank has taken further steps to stimulate the economy: reducing the interbank rate and expanding quantitative easing. The value of bonds the ECB buys has increased from EUR 60bn to EUR 80bn. The forecasts for inflation and growth were lowered to 1.3% and 1.7% respectively in 2017. Mario Drahgi also stated that he did not foresee more rate cuts this year; however, the leader of the ECB has made this assertion before and later gone back on his word. On the day of announcement the euro experienced a 2% rise and shares in eurozone banks rallied before losing most of their gains later in the day. Yields on investment grade debt have plunged. The ECB as a buyer of highly rated corporate debt has caused a flood of companies selling corporate bonds. The 4 days following the ECB announcement saw bond sales of EUR 30bn. On March 16th, EUR 17bn of new corporate and bank debt sales were announced, the busiest day for bond issuance since May 2001. AB InBev sold the largest ever euro-denominated bond with the total size of the order book being EUR 31bn. The debt is intended to fund their takeover of SAB Miller and is part of a growing trend of increased bond issuance to fund M&A activity.

Key Indicators

  • GDP Growth Rate: 0.4%
  • Unemployment Rate: 10.4%
  • Wage Growth: 1.5%
  • Inflation Rate: -0.1%
  • Interest Rate: 0%
  • German Bund 5y yield: -0.36%
  • Manufacturing PMI: 51.6
  • Industrial Production: 2.8%
  • Consumer Confidence: -9.7
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