This technical breakdown in the euro was significant, because the 20% rise over the past year was driven by Europe’s commitment to “rearming” — rebuilding its hard power. The global investment community saw this as pro-European asset prices. Europe would be spending. Europe was back.
And by the middle of last year, Christine Lagarde, head of the European Central Bank, used the opportunity to promote the euro as having the potential to supplant the dollar as the world reserve currency. She implied that the eroding trust in the dollar was “the global euro moment.”
Similarly, we have this declining trend in Italian 10-year bond yields over the past three years. This represents borrowing costs for the most fiscally fragile major European country.
The falling trend in this chart was driven by European rate cuts, falling inflation, the “Europe is back” narrative and (related) assumptions that the spending would spur a transformation in the European economy (i.e. reduced sovereign debt risk).
So, despite its 137% debt-to-GDP, Italy has been borrowing at rates cheaper than the U.S.
That said, the trend has broken here too. Italian yields are breaking out — in the country most vulnerable to rising borrowing costs.
So, the euro broke down on the first trading day of the U.S./Iran war.
And in day four, Italian bond yields broke out.
And this next chart is key to both …
In 2022, Russia disrupted Europe’s pipeline gas supply, and it took three years and hundreds of billions of dollars to build an alternative — primarily through LNG imports from Qatar. This week, that alterative went offline — Qatar’s total production has halted, removing about a fifth of global LNG from the market.
So, Europe’s backup supply has failed.
This means more expensive energy is coming for Europe. And that’s inflationary for an energy importing continent.
The market is starting to price in an about face by the European Central Bank on the direction of interest rate policy.
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