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Eurozone Meltdown Financial Catastrophe Stress Test

Sovereign default is a failure or refusal by a country’s government to make a repayment of national debts. Consequences include devaluation of the principal, as well as loss of yield from the bond. 

This report explores the impact of unexpected devaluation of fixed income assets resulting from a cascade of sovereign debt devaluations caused by the sequential exit of countries from a currency union. Political pressures force a bloc of European countries into a cascade of exits from the currency union. The speed and rapid incidence of multiple countries exiting is the most significant dimension of the scenario. 

Overview

The exit from the Euro spreads by contagion of similar political and economic issues across a number of countries and affects other economies that are typically thought of as being core countries of the Eurozone. These problematic political drivers might still endanger the currency union, although the pure financial market risks now seem to be under control as a powerful rescue architecture has been set up since 2011.

The standard scenario’s impacts are limited to peripheral countries however in the more severe scenario variants, there is a total Eurozone meltdown with severe global effects.  

The scenario causes a worldwide recession lasting just over a year (approximately five to six fiscal quarters). 

Key findings

  • The overall expected output loss, expressed as lost global Gross Domestic Product during the scenario compared with the projected rate of growth without the catastrophe occurring ("GDP@Risk"), is between $11.2, $16.3 and $23.2 trillion, depending on the variant narrative. 
  • The Great Recession of 2007-2011, comparatively, saw a loss of $20 trillion in 2015 dollar estimates. 
  • Best and worst performances (within equities and stocks) are the German equity index (DAX) and the best performing stocks is Japan (N225). 
  • The worst performing fixed income bonds are the German while the US bonds perform the best.
  • For portfolio protection it is recommended that equity allocation is shifted away from Europe towards Japan and away from Euro fixed income towards US fixed income.