As European capital appears to be redirecting from unstable U.S. investments, it seems to be financing the region’s fiscal growth without incurring additional costs.
This may sound overly optimistic, but the trends observed in European government bonds and the euro over the last month indicate that the continent might be acquiring some of the “exorbitant privilege” traditionally enjoyed by the United States as a safe-haven destination and the issuer of the world’s primary reserve currency. Due to Donald Trump’s trade policies and frayed alliances across the Atlantic, a vast European region with surplus savings might be more inclined to support itself rather than the increasingly mundane American economy.
Though it remains uncertain if additional global savings will flow into Europe, some financial institutions are beginning to speculate that the continent could attract risk-averse investments.
According to JPMorgan’s debt strategists, “Eurozone government bonds, particularly those of Germany, could stand to gain if there is a shift in official sector demand away from U.S. Treasuries amid a continued U.S.-led trade dispute.”
Market observers are keeping a close eye on how much of this shift is already taking place within government debt markets.
No Additional Costs
Just over a month ago, in response to President Trump’s dual shocks, Germany opted to relax its “debt brake,” designating nearly a trillion euros ($1.14 trillion) for new spending on defense and infrastructure to bolster its security and economy. This marks the most significant fiscal uplift relative to GDP in contemporary German history, surpassing both the post-World War Two Marshall Plan and the spending associated with reunification after 1990.
In addition, the European Union has specified a plan to mobilize 800 billion euros in new defense expenditures over the next four years, which includes around 150 billion euros in joint borrowing.
Predictably, the initial announcement led to an increase in borrowing costs for German and eurozone sovereign bonds, with 10-year German yields experiencing the largest one-day rise in the euro’s 26-year history.
However, as the trade conflict with the U.S. has unfolded chaotically, causing pressures on Wall Street stocks and U.S. Treasuries, those euro borrowing costs have retraced nearly all their earlier increases—eliminating most gains realized after the German government’s announcements on March 5.
This trend is not unique to Germany, as other eurozone countries are experiencing similar movements.
On Monday, borrowing rates for Italian government bonds sharply decreased—partly due to an unexpected upgrade in SP Global’s sovereign credit rating on Friday, despite projections of a 138% debt-to-GDP ratio for next year.
The current situation suggests increased borrowing in the eurozone, a long-term fiscal boost for growth—all at essentially the same cost of debt. What’s not to appreciate?
Alongside this, the euro has surged against the dollar lately, partly because of apprehensions about capital flight from the Transatlantic region. This potential disinflationary effect amidst a trade dispute has led to speculation that the European Central Bank might adopt a more aggressive easing of credit policy than previously anticipated, potentially starting this week. This has contributed to lower baseline borrowing costs throughout the eurozone.
Absorption Potential
But is the capital genuinely moving back to a new European safe haven?
The sheer volume of investment savings in the United States is significant; however, the potential shift of those funds remains difficult to gauge beyond the notable changes in exchange rates.
Dario Perkins, chief economist at TS Lombard, reports on Federal Reserve data indicating that global exposure to U.S. equities has reached about $14 trillion since 2012, with Europe accounting for approximately half of that increase—more than the market capitalization of the Euro Stoxx 50.
If European investors decide to repatriate these funds, it could indeed benefit European assets, creating a “reflexivity” effect where the weakening dollar diminishes the appeal of U.S. investments.
Perkins stated, “If these funds return during the current ‘risk-off’ climate, they are more likely to enter European bond markets than equities.”
Can Europe’s expanding bond markets accommodate this influx?
Currently, the volume of outstanding European government bonds is around $10 trillion ($11.4 trillion) and is on the rise—approaching nearly half the size of the $27 trillion U.S. Treasury market.
Citi research shows that 11 of the 20 eurozone governments constitute 98% of the total bond market, with credit ratings ranging from AAA to BBB-. Among the five largest issuers, liquidity is considerable, with an average bid-offer spread of less than 1 basis point throughout the previous year.
If just half of the European funds held in the U.S. return, and half of that is invested in government bonds, it could yield nearly 2 trillion euros in new financing—adequately covering the costs of Germany’s and the EU’s new defense-related borrowings. This doesn’t even factor in other global public funds potentially shifting from Treasuries.
Of course, it’s rarely as straightforward as this.
Nonetheless, judging by recent bond market trends, new eurozone borrowing is already occurring at no additional cost.