As European capital seems to be returning from unstable American investments, it is enabling the region’s entire fiscal expansion without incurring additional expenses.
This situation, while seemingly too good to be true, is reflected in the recent performance of European government bonds and the euro, suggesting that the region may be experiencing some of the “exorbitant privilege” previously enjoyed by the United States, which has been viewed as a safe haven and holds the status of the sole reserve currency. Due to the repercussions of Donald Trump’s trade policies and disruptions in Transatlantic relations, Europe, characterized by its surplus savings, may be inclined to self-fund rather than support the increasingly conventional American economy.
It remains uncertain whether Europe will attract more savings from the global market; however, some financial institutions are beginning to speculate that the continent may indeed draw in such capital.
According to JPMorgan’s debt strategists, “Euro government bonds, particularly those issued by Germany, could gain from a scenario where there is a shift in official demand away from U.S. Treasuries amid a prolonged trade conflict led by the U.S.”
The degree to which this shift is already unfolding is being monitored closely within government debt markets.
No Additional Cost
Just over a month ago, Germany responded to the dual challenges presented by Trump by easing its “debt brake” policy and allocating nearly a trillion euros ($1.14 trillion) for new debt-financed initiatives targeting defense and infrastructure aimed at enhancing its security and economic framework. This represents the most significant fiscal expansion relative to GDP in contemporary German history, surpassing both the post-World War Two Marshall Plan and the spending incurred during Reunification in 1990.
Additionally, the European Union outlined plans to mobilize 800 billion euros for new defense expenditures over the upcoming four years, which includes approximately 150 billion euros in joint borrowing.
Unsurprisingly, the initial response saw an uptick in German and euro sovereign borrowing costs to reflect this increased borrowing, with 10-year German yields experiencing their largest one-day surge in the euro’s 26-year existence.
However, as the trade conflict led by Trump progressed chaotically, impacting both Wall Street and U.S. Treasuries, the borrowing costs in euros have subsequently decreased almost as quickly as they had risen last month, effectively negating nearly all increases following the new announcements from the German government on March 5.
This trend is not isolated to Germany, as it is evident across the broader euro government debt market.
On Monday, Italian government bond rates experienced a sharp decline, propelled by a surprising upgrade to its sovereign credit rating by SP Global, despite forecasts of a 138% debt-to-GDP ratio next year.
The outcome thus far indicates an increase in eurozone borrowing, yielding a long-term fiscal boost to growth—all for essentially the same cost of debt. What’s not to appreciate?
Additionally, there has been a marked rise in the euro’s value against the dollar, partly fueled by concerns over capital flight from the Atlantic. The potential disinflationary effects amid an ongoing trade conflict have led to speculation that the European Central Bank may implement more aggressive credit easing than previously anticipated, possibly starting this week. This has consequently contributed to a decrease in base borrowing costs across the eurozone.
Absorption
But is capital truly repositioning itself to a new European safe haven?
The scale of investment in U.S. markets is substantial, but whether it has unsettled investors or is on the verge of relocating is complicated to discern beyond the significant currency fluctuations alone.
Dario Perkins, the chief economist at TS Lombard, points to Federal Reserve data indicating that approximately $14 trillion in exposure to U.S. equities has accumulated globally since 2012, with Europe accounting for about half of that figure—more than the market capitalization of the Euro Stoxx 50.
If these European investors were to return such flows, it could indeed provide a boost for European assets, creating a sense of “reflexivity,” where a weaker dollar would diminish the relative appeal of U.S. investments.
Perkins noted, “If these flows are redirected in the current risk-averse climate, they are more likely to be directed towards European bond markets rather than equities.”
Can Europe’s expanding bond markets handle this influx?
Currently, the total outstanding European government bonds stand at around $10 trillion ($11.4 trillion) and are increasing, drawing closer to half the size of the $27 trillion U.S. Treasury market.
Citi’s research indicates that 11 out of 20 eurozone sovereigns comprise 98% of this total, with ratings for these 11 ranging from AAA to BBB-. The five largest maintain impressive liquidity, with an average bid-offer spread of less than 1 basis point throughout last year.
If merely half of the European investments currently in the U.S. return, and half of that is allocated to government bonds, it could yield nearly 2 trillion euros in new funding—more than sufficient to cover the costs of Germany and EU-wide defense initiatives. This calculation does not even take into account other global funds shifting away from U.S. Treasuries.
Of course, outcomes are rarely as straightforward as they appear.
Nevertheless, based on the developments in the bond market over the past month, new euro borrowing is already occurring without additional costs.
The views presented herein are solely those of the author, a columnist for a financial news organization.