Mike Dolan
As European money appears to be heading home from wobbling American assets, it’s underwriting the region’s entire fiscal expansion at no extra cost.
While that seems too neat to be true, the behaviour of European government bonds and the euro over the past month suggests the bloc may well be assuming some of the “exorbitant privilege” the United States has enjoyed for decades as a perceived safe haven and owner of the sole reserve currency. Thanks to Donald Trump’s global trade war and broken Transatlantic alliances, a gigantic European continent of surplus savings may just be minded to fund itself rather than the increasingly unexceptional American economy.
Whether it draws additional savings from the rest of the world is yet to be seen, but some banks are now openly speculating about Europe attracting those safety seeking flows.
“Euro government bonds, especially German government bonds, could benefit from a risk scenario of shifting official sector demand away from U.S. Treasuries in a prolonged U.S.-led trade conflict,” JPMorgan’s debt strategists told clients this week.
The extent to which some of this is already under way is being watched closely in government debt markets.
No extra cost
Just over a month ago, Germany’s response to the twin Trump shocks had been to take its foot off its own “debt brake” and earmark almost a trillion euros ($1.14 trillion) in new debt-funded spending on defence and infrastructure to boost its security and economy. In short, that’s the largest fiscal boost as a share of GDP in modern German history – exceeding both the post-World War Two Marshall Plan and Reunification spending post-1990.
On top of that, the European Union at large outlined how 800 billion euros of new defence spending could be mobilised over the next four years, including some 150 billion euros of joint borrowing.
Unsurprisingly, German and euro sovereign borrowing costs jumped initially to reflect the huge extra borrowing, with 10-year German yields at one point recording a biggest one-day jump in the euro’s 26-year history.
But as the Trump trade war has unfolded messily and both Wall Street stocks and U.S. Treasuries creaked, those euro borrowing costs have fallen back by almost as much as they rose last month – wiping out virtually all of gains seen after the new German government announcements on March 5.
And that’s not just Germany, it’s across the euro government debt space.
Italian government bond borrowing rates were the latest to tumble sharply on Monday – aided by a surprise upgrade to S&P Global’s sovereign credit rating on Friday despite its forecast for a 138% debt/GDP ratio next year.
The upshot to date is we get more euro zone borrowing, a longer-term fiscal boost to growth – and all for essentially the same debt cost. What’s not to like?
Part of the piece last week has been a sharp surge in the euro against the dollar – in part due to concern about Transatlantic capital flight. The potential disinflationary impact of that in the middle of a trade war has spurred speculation that the European Central Bank will ease credit policy faster and deeper than previously thought – starting as soon as this week. And that’s helped drag base borrowing costs down across the euro zone.
Absorption
But is money really coming home to a new European haven?
The scale of investment saving in the United States is undeniable, whether it’s already unnerved or about to jump ship is still difficult to see beyond the big exchange rate shifts themselves.
TS Lombard’s chief economist Dario Perkins cites Federal Reserve data that shows how the world accumulated an exposure to U.S. equities of around $14 trillion since 2012, with Europe responsible for roughly half of that accumulation, or more than the market cap of the Euro Stoxx 50.
If European investors repatriated these flows, he said, that would certainly provide a tailwind for European assets, even bringing a degree of “reflexivity” because dollar weakness would itself reduce the relative attractiveness of U.S. investments.
“If these flows are repatriated in the current “risk off” environment, they are more likely to find their way into European bond markets rather than equities,” Perkins wrote.
Can Europe’s growing bond markets absorb that?
Right now, European government bonds outstanding are in the region of 10 trillion euros ($11.4 trillion) and rising – and closing in on half the size of the $27 trillion U.S. Treasury market.
According to Citi research, 11 of the 20 euro sovereigns make up 98% of the total size, with credit ratings of those 11 ranged between AAA and BBB-. Of the five largest, liquidity was impressive with a bid-offer spread of less than 1 basis point on average through last year.
If only half of the European money stateside returned and only half of that went to government bonds, it could see almost 2 trillion euros of new funding – covering the cost of German and EU-wide new defence borrowing comfortably. And that’s not including other global public funds switching from Treasuries.
Of course it never works out quite as simply as that.
But judging from bond market developments over the past month – new euro borrowing is already coming at no extra cost.
(The author is a columnist for Reuters)
Published – April 15, 2025 08:58 pm IST
