European Debt Crisis and Crude Oil Market

This assignment examines the influence of the European debt crisis on crude oil markets. It explores how factors such as Greece's bailout, investor risk aversion, and economic slowdowns have affected crude oil prices. The analysis delves into the interplay between bond markets, global economic conditions, and the supply-demand dynamics of the oil market. Additionally, it considers the role of central bank interventions like quantitative easing in mitigating the impact of the crisis.

European Sovereign Debt Crisis
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Impacts on the bond markets and other markets
The European sovereign debt crisis had a great impact on markets and several
implications. The impacts of the debt crisis were so deep to the world's economy that
we can still observe them today especially at the Eurozone's countries such as Greece,
Spain, Italy, Ireland and Portugal (Lane, 2012). High volatility of the euro markets
has been a significant factor during the crisis period. Those high levels of volatility
can lead to high interest rates of borrowing for the countries with debts and as a
consequence to high bond yield spreads.
Several European countries at the same time faced collapse in their financial institutions
and government debt. This led to rising spread amongst bond yield spreads in
government securities from the year 2008 which started in Iceland with its banking
system collapse and spread to Greece, Ireland and Portugal (Von Hagen, 2011).
Fig. 2. Bond yield spreads for EU-15 central governments, January 1991-May 2009.
As we can see in figure 2 the bond yield spreads for the EU-15 central governments
during May 1991 till October 2006 were low, whereas the bond yield spreads during
October 2006 and May 2009 were extremely high. Investors seeing higher associated
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risks with bond investing needed higher return for compensation of such risks. There
was a vicious cycle present that led to surge in demand for higher yield bonds leading
to higher borrowing costs for all country’s that were experiencing crisis situation.
Fiscal strain operating within the country especially in Greece led to demands for
higher yields and subsequently investors losing their confidence affecting selling.
European Union acted gradually by opting for bailouts of nations especially troubled
economies. In totality the European Union along with International Monetary Fund
disbursed a total of 110 billion euros to Greece alone. Then Portugal and Ireland
opted for bailouts, following establishment of EFSF providing emergency lending to
countries in difficulty. The Long Term Refinancing Operation (LTRO) established
programs for bailouts for countries. Various countries held on to their reserves for
their economic growth and boost their bank balances. Several endeavours were made
by European policy makers for stabilising their financial markets, to save their fiscal
health. With ECB coming into action investors became bully globally reinvesting
again in bond markets of smaller nations.
Government bonds are historically considered as the safest investment. After the crisis,
investors starting to lose their confidence in the stock market and as a result they stop
investing on it. Consequently, investors turned to government bonds and this led to a
rise in the demand of bonds (Aizenman, 2013). Therefore, Central Banks tried to
increase their holding of government bonds. Because of the increased demand, the
price of the bonds has been raised.
European countries believed collapse or Euro along with financial contagion by the
International Monetary Fund (IMF). Several countries in the European Union
including Greece received bailout funds for preventing crisis within their economy
for slowing down of public sector debt. Demand for governmental bonds or sovereign
paper rising which eventually led to their inability to pay (Arghyrou, 2012). These
banks resorted to third party financial institutions as European Central Bank (ECB),
European Financial Stability Facility (EFSF) and International Monetary Fund (IMF)
for their payments. There were a total of 17 countries belonging to the European
Union that voted for creation of EFSF for resolving European debt crisis.
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Source, Bloomberg : Euro Index from 2001-2012
The above graph shows the historical price graph of the European government bonds 7-
10 years of maturity. The graph shows that the price of the government bonds gone
very high from 2001 till 2012 and it is still rising. Inability to repay government
financed debt led to refinancing of such instruments (Mink, 2013). The primary
drivers of European Sovereign Crisis was financial crisis which was a direct
consequence of Greet Recession in 2008 – 2012, which eventually was related to real
estate market property bubbles. Greece government had gross underestimated its
budget deficits which led to financial crisis and rising rates of the bond market.
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Source, Bloomberg : Bond Indices for US government 7-10 year, Bloomberg Finance
L.P.
The above graph shows the US 7-10 years of maturity price of the government bonds
from 2001 till 2012. Again, because of the correlation of the European economy and
the US economy the sovereign debt crisis has led the bond prices to high levels. What
is more, if we observe the graph we can clearly notice that during 2008 and 2012
there is high volatility which indicates the high demand for government bonds during
that period. The US economy due to persistent demand in debts had to raise their rates
for fiscal position (Beirne, 2013). European countries were also made unsustainable
due to rising levels of unsustainability.
The stock market is different to the bond market. During credit instability the price of the
shares of the firms will decrease. Furthermore, when economies enter into recession
the expected profit of the firms is going to be lower thus the firms are going to pay
less dividend. Therefore, investors will lose their interest in the equity market and
they will eventually turn to other markets such as bond markets. The following graphs
drawn from Bloomberg are showing the price levels for S&P 500, EURO STOXX
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and NIKKEI 225 for the period of 2000 till 2012. As we observe there is high
volatility to all three equity markets. Furthermore, the low and high prices of the Euro
equity index and the Japanese equity index are quite high whereas the prices of the
US equity index are low. During January of 2008 the prices fall down for the EURO
STOXX and the NIKKEI 225 and the S&P 500 experienced great loses during
November of 2008. The S&P 500's prices went up on March of 2009 whereas the
EURO STOXX's and the NIKKEI's 225 prices remained low.
Though initially there was a substantial pool of investors in the equity market, but with
rising debt levels investors started diverting their funds. There was high inflow of
funds that took place in the debt market, with investors booking profits in the equity
market. Diverted funds from the stock market of Europe led to crisis in the equity
market as well (Arezki, 2011). Low liquidity led to tremendous pressures on
companies to dividends, who felt constrained now to be able to pay off debts. With
collapse of governmental debt, there was pressure building in the equity market,
where panic selling rose to a substantial extent. Debt crisis reignited panic across all
markets, especially in equity and also in commodity markets. With countries opting
for bailout situations, there was a wave of panic that frightened Spain and Italy.
Double-dip recession with opposition to tax increase and cuts in welfare funds, panic
swept across entire stretches of European nations. Spain and Italy being centred
around hostilities in their bond market fears, made it a suitable target for nervous
traders. Investors were interested in safe avenues as Gold and US dollars from all
over Britain, Germany and US.
Source, Bloomberg : EURO STOXX INDEX from 31/10/2000 - 29/10/2012
Source, Bloomberg : S&P 500 INDEX from 31/10/2000 - 29/10/2012
Source, Bloomberg : NIKKEI 225 from 31/10/2000 - 29/10/2012
During the sovereign debt crisis the world's economy collapsed. There were many
implications in all type of markets such as the derivatives, commodities, foreign
exchange market and of course implications in the gold prices and the oil prices.
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After the housing bubble, the commodity market entered its own bubble. From 2007
till summer of 2008 oil prices went very high and then plunged to very low price by
the end of 2008. Oil though was not the only commodity to experience swings in the
prices. Table 1 illustrates the declines for some of the commodities during 2008
compared to the declines during 1970 - 2007.
Swing in oil prices led to oil companies losing millions of dollars in the market as well as
in their businesses. Oil price was highly destabilised during recession leading to low
levels of profit margins (Beetsma, 2013). Other commodity prices also experienced
tremendous swing that led to fluctuations in commodity market as well. Implications
of Euro Sovereign Debt crisis led to downturn in all aspect of the European economy.
There was a sharp decline in demands across Euro zone countries through all relevant
channels of international trade. Crude oil prices have become extremely volatile in
the international markets. World economy and financial market trends have said to
influence influential crude oil price drivers. European bank stocks along with
European markets as a whole performed worse at the time of crisis, which led nations
to underperform. Political influence arising from crisis situation was immense that
pushed nations towards austerity or cutting gaps in revenues and outlays. There were
mixed thoughts that led to European nations often evaluating abandoning Euro. This
would impact regional policy and countries would have more freedom to include
individual independent policies. There were 17 nations in totality that depended on
same currency and common policy. With abandoning of the same there would be an
impact of large magnitude on global economy and its financial markets.
Deepening debt in the European markets led to downward trends in crude oil markets.
With Greece re-opting for bailout, investors view on crude price remained bearish.
There had been several fundamental challenges along with failure of the banking
system that led to Greece asking for repeated loans. With tandem in world economy
and financial markets, oil supply and demand situations have also been affected. The
fundamentally upward crude prices have been lagging behind providing future course
for the world economy. Currently bond markets have gone to lower levels which has
driven prices and brought down prices of bonds. Greater investor risks in bond
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market, slows down economic growth of countries leading to deflation. While ECB
continues its efforts by slashing of interest rates, it aims to further include a
quantitative easing program that had earlier been used in U.S. Federal Reserve.
Table 1. The commodity bubble, Source: World Economic Outlook Crisis and Recovery
The commodity market outlook along with bond and equity markets remained bearish,
with rising attention to geopolitical tensions. European debt crisis is a multi-year debt
crisis which initiated in 2009. Various scholars attribute consolation of currency
union without fiscal union being primary cause of the crisis. The crisis deepened as
several banks in Europe owned a significant amount of bonds which negatively
reinforced banking systems. Though there were several financial measures that were
implemented to resolve crisis situation, bailout of Greece was fundamental to
resolving such situations. Ireland and Portugal was able to significantly return from
bailout situation and managing their crisis. There was adverse effect on labour market
and unemployment rates as well on these European countries. Political impacts on
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these countries were also immense that influenced various outcomes for several
elections.
Reference Lists
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Aizenman, J. H. 2013. What is the risk of European sovereign debt defaults? Fiscal space, CDS
spreads and market pricing of risk. Journal of International Money and Finance, 37-59.
Arezki, R. C. 2011. Sovereign rating news and financial markets spillovers: Evidence from the
European debt crisis.
Arghyrou, M. G. 2012. The EMU sovereign-debt crisis: Fundamentals, expectations and
contagion. . Journal of International Financial Markets, Institutions and Money, 658-677.
Beetsma, R. G. 2013. Spread the news: The impact of news on the European sovereign bond
markets during the crisis. Journal of International Money and Finance, 83-101.
Beirne, J. &. 2013. The pricing of sovereign risk and contagion during the European sovereign
debt crisis. Journal of International Money and Finance, 60-82.
Lane, P. R. 2012. The European sovereign debt crisis. The Journal of Economic Perspectives,
49-67.
Mink, M. &. 2013. Contagion during the Greek sovereign debt crisis. Journal of International
Money and Finance, 102-113.
Von Hagen, J. S. 2011. Government bond risk premiums in the EU revisited: The impact of the
financial crisis. European Journal of Political Economy, 36-43.
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