The return of European capital from fluctuating American assets appears to be facilitating an extensive fiscal expansion within the region without incurring additional costs.
This scenario, while it seems almost too convenient, is supported by the recent behavior of European government bonds and the euro, indicating that the continent may be beginning to enjoy a version of the “exorbitant privilege” that the United States has harnessed for years as a favored refuge and sole reserve currency holder. In light of the trade tensions initiated by Donald Trump and fractured Transatlantic relations, a vast continent laden with surplus savings in Europe seems poised to finance its own needs rather than those of an increasingly average American economy.
It remains to be seen whether Europe will attract further global savings, but several banks are beginning to speculate about the possibility of Europe becoming a haven for safety-seeking capital.
According to debt strategists at JPMorgan, “Euro government bonds, especially those from Germany, may benefit from a scenario where official sector demand gradually shifts away from U.S. Treasuries amid an extended U.S.-led trade conflict.”
The degree to which this shift is already occurring is being closely monitored within government debt markets.
No additional expenses
Just over a month ago, Germany responded to ongoing challenges posed by U.S. policies by relaxing its “debt brake” to allocate nearly a trillion euros ($1.14 trillion) for new debt-financed initiatives aimed at enhancing both defense and infrastructure. This marks the most substantial fiscal stimulus relative to GDP in modern German history, surpassing even the Marshall Plan after World War II and post-1990 Reunification spending.
Moreover, the European Union has outlined a plan to mobilize 800 billion euros for new defense spending over the next four years, which includes around 150 billion euros in joint borrowing.
Initial reactions led German and eurozone borrowing costs to rise sharply, with 10-year German yields witnessing a notable single-day increase, setting a record in the euro’s 26-year history.
However, as the trade war led by Trump has muddled and both Wall Street shares and U.S. Treasuries have faltered, those euro borrowing costs have decreased almost completely, negating the earlier hikes following fiscal announcements from Germany on March 5.
This trend of declining costs extends beyond Germany and throughout the euro governmental debt landscape.
On Monday, Italian government bond borrowing rates experienced a significant drop, aided by an unexpected upgrade in SP Global’s sovereign credit rating despite a projected 138% debt-to-GDP ratio for the upcoming year.
The implication so far is that we are witnessing increased eurozone borrowing, contributing to a sustained fiscal boost for growth—all effectively at the same cost of debt. What could be more appealing?
Recently, the euro has surged against the dollar, partly due to fears of a capital exodus from the Transatlantic region. Such disinflationary pressures amid a trade conflict have led to speculation that the European Central Bank may adopt a more accommodating credit policy sooner than anticipated—possibly even within the week—resulting in lower base borrowing costs across the eurozone.
Absorption
But is there truly a shift of funds back to a revamped European investment haven?
The scale of investment held in the United States is substantial, and whether this has caused unease or will soon prompt a migration remains uncertain, beyond the significant currency fluctuations.
Chief economist Dario Perkins from TS Lombard points to Federal Reserve data indicating that the world has gathered approximately $14 trillion in U.S. equity investments since 2012, with Europe accounting for roughly half of this accumulation, exceeding even the market capitalization of the Euro Stoxx 50 index.
If European investors were to return these funds, it could enhance the outlook for European assets and introduce a level of self-reinforcing dynamics, as a weaker dollar would diminish the comparative appeal of U.S. investments.
Perkins noted, “In a risk-averse climate, these repatriated flows are more likely to invest in European bond markets instead of equities.”
Can Europe’s expanding bond markets accommodate this influx?
Currently, outstanding European government bonds total around $10 trillion ($11.4 trillion) and continue to grow, nearing half the scale of the $27 trillion U.S. Treasury market.
Citi research reveals that 11 out of 20 euro sovereigns account for 98% of the total market size, with their credit ratings ranging from AAA to BBB-. The five largest sovereigns exhibit strong liquidity, averaging a bid-offer spread of less than one basis point throughout the last year.
If just half of the European funds currently in the U.S. were repatriated, and half of that portion directed towards government bonds, it could yield nearly 2 trillion euros in new financing, sufficiently covering the costs of new borrowing for German and EU defense initiatives, not accounting for other global public funds moving away from Treasuries.
Nonetheless, situations rarely unfold as simply as theorized.
However, based on developments within the bond market over the past month, new borrowing within the eurozone appears to be occurring without incurring additional costs.