We’ve talked about Europe this week.
EU leaders met yesterday with one important job: convince the world that Europe can fund itself, and that its politics can still execute, before markets decide to test the system.
That said, they admitted they have to move fast.
Why? The clock is ticking. Regime change at the Fed will be here officially in three months, and as we’ve discussed in my daily notes, it will create significant vulnerabilities for Europe.
With that in mind, the “plan” is “One Europe, One market” (consolidating borrowing power, and turning Europe’s savings into domestic investment). And they set a June deadline, which is public acknowledgement of the urgency.
But they’re already setting expectations for a fracture. They’re laying the groundwork for a failure of unanimity.
The European Commission President, Von der Leyen said if all 27 can’t agree (small chance that they would), they are prepared to move ahead with a smaller group — group of 9. A coalition of the willing.
This will be another moment when the structural flaws of the European Union and the European Monetary Union get exposed. One currency, one central bank — but many fiscal authorities and fragmented decision-making.
The euro area’s stability ultimately depends on (the market’s) confidence that member countries can work together and execute under stress.
For now, markets are still complacent. European bank stocks have actually outperformed U.S. banks in this cycle (chart below). If the market starts to become unconvinced Europe can “muddle-through” we’ll see it in this chart (i.e. divergence).
Interestingly, today (the first trading session after this meeting), we had divergence — European banks down 3.2%, U.S. banks were up 0.5%.
And the divergence showed up in the real stress gauge: spreads.
Italian yields rose on the day while German yields fell — a widening of the risk premium.
Italy remains an X-factor in the broader fiscal integration of Europe. If Meloni ends up among the unwilling, then the market may start to consider the odds that the integration effort could turn into disintegration of Europe.