Let's talk about some spots in Europe that are flashing warning signals.
It's all related to vulnerabilities in the European sovereign debt markets.
First, for comparison, the U.S. interest rate curve is steepening and the 30-year is at two-decade highs. But the 10-year sits at the high end of the same 75 basis point range it has held all year, still well below the significant 5% level. Long-end steepening with inflation expectations anchored is a term premium story. It is not a stress story.
Europe, on the other hand, is a stress story.
Italy's 10-year is at 4.02%. France is at 4.08%, the highest since 2009. And Germany, the anchor for the entire system, is at 3.23%, a 15-year high.
Notice, France is now borrowing more expensively than Italy. The euro zone's second largest economy, is paying more than the country everyone has spent a decade worrying about.
Is this periphery stress? Or is this is the core repricing?
Look at Germany. It's the safest credit in the euro zone, the benchmark every other European borrower is priced against. It's now funding itself at a level it hasn't paid since 2011.
Then there's the UK, where the 10-year is back above 5%.
As you can see in the chart above, this 5% area for UK yields has been tested repeatedly over the past few months. It hasn't sustained.
But look at the other spike in that same chart. The one that compelled the Bank of England to step in back in 2022, to resolve a liquidity crisis that was threatening to become a solvency crisis.
That spike revealed leverage in the financial system. As Warren Buffett says, when the tide goes out you see who's swimming naked.
The tide went out, and the margin calls followed. Then forced liquidations, which drove yields higher, which brought more margin calls, and more forced liquidations.
It was a self-reinforcing debt spiral, and it happened fast. Major pension funds came within hours of insolvency. The Bank of England was forced into emergency bond buying to stop it, as the buyer of last resort.
It was never that 4% or 5% was a magic number.
It was a threshold that revealed the leverage already sitting in the system.
Now, what else happened in European bond markets in 2022?
The European Central Bank was forced back into the business of backstopping the weak spots of Europe. Italian 10-year yields crossed 4% that June, and that was enough to warrant an ECB response.
Italy is at 4.02% today. There is no response.
Why? In 2022, Italy at 4% meant a spread of roughly 240 basis points over German bunds, because Germany was yielding 1.6%.
Today Italy at 4% is only 79 basis points over Germany.
Same Italian yield. But a rising anchor.
And this time around the ECB isn't fighting the rise in yields, it's contributing to it. The market is pricing in a 90% probability of an ECB rate hike on September 10, into an economy that is barely growing.
Why would they hike into that? Because of this chart.
This "gas ratio" shows the multiple Europeans pay for natural gas relative to Americans. It closed Friday at a new war high of 7.6 times, 145% above where it stood before the February strikes.
That feeds straight into European inflation. And a central bank's response to inflation, even energy-driven inflation, is rate hikes. More upward pressure on yields.
And the energy shock is not letting up.
Scott Bessent said last week the campaign has moved from Epic Fury to Economic Fury, that the pressure has been raised again, and that Washington will apply (on Iran) measures of economic isolation unlike anything in the history, alongside a continued blockade of the Strait of Hormuz.
So Europe is refinancing debt at 15-year-high yields, with a central bank raising rates rather than supporting the market, and an energy shock that Washington intends to extend.
In 2022, the buyer of last resort arrived (to supress yields). Today the central bank is the one applying the pressure (upward pressure on yields).
All of this, while European equities sit at or near record highs.
So, the bond market is pricing the highest cost of government money in fifteen years across the three largest economies on the continent. The stock market is pricing the best conditions ever.
That's dislocation.
