The future of the euro and that of the EU are inextricably tied according to our latest white paper, I co-authored with Jacek Rostowski, a former Deputy Prime Minister and Finance Minister of Poland. The big question for us is how could today’s political landscape impact the region in the coming months and years – and what does that mean for investors?
In the paper, “A Map for the Future of the Euro: Navigating Political Conflicts”, Rostowski and I provide an overview of Europe at a critical crossroads, facing potentially divisive forces such as populism, anti-NATO and anti-trade rhetoric from the U.S., and rising tensions with Russia.
Below is a summary of the top takeaways institutional investors will need to monitor in the coming months — and what these scenarios could potentially mean for investment risk in the region going forward.
The rise of populism – The European political landscape is pockmarked with populism as anti-globalization and anti-European sentiment continue to rise. Driven by issues such as mass migration, cultural liberalization, and national sovereignty, populist sentiment is, as we note, making Europe’s political battleground “hot” and harder to navigate.
North versus South: The spirit of populism differs vastly in Northern and Southern Europe. Northern populists in countries like the Netherlands tend to be right-leaning and populists in southern countries, like Italy and Greece, lean left. This north-south divide adds further fragmentation at a time when centrists are pushing for consensus in Europe. Could different forms of populism torpedo all hopes of cooperation?
Weakening ties with U.S.: With a big U.S. focus on “America First”, the risk of U.S.-EU trade war is real and could see Germany — with its huge trade surplus with the U.S. — hit the hardest of all. At the same time, we see such tensions giving rise to the very real possibility that Europe’s key defence guarantee might be hollowed out. No fan of NATO, Trump has characterized the EU as free-riding on U.S. support.
The rise of Russia: Russia is creating more instability in the region — President Vladimir Putin continues to promote Russian interests and to expand its sphere of influence, often at the expense of European interests. With NATO becoming increasingly fragile, the political rebalancing taking place between Europe and the U.S. will no doubt rattle Germany. The country’s high trade surplus and its overtly export-oriented economy has fueled discontent among allies, particularly the U.S. with whom its trade surplus topped €66 billion in 2017.
Energy and military strength: Germany is also reliant on imported energy. In 2016, 32% of its coal and almost 40% of its oil came from Russia. We point out that Germany’s energy dependence underlines how frail its bargaining power is in a Europe facing disintegration and diminished security in the face of a weakened NATO. France could emerge a winner, with its strong military and a more favourable trade surplus with the U.S. Energy-wise, it’s also heavily reliant on its own network of reactors which are majority owned by the government.
Implications for investors – These developments will certainly impact markets and the euro but the extent of that impact depends on which way Europe evolves. Serious progress between countries and further integration is likely to lead to significant and sustained compression of country risk premia across bonds, credit and equity. However, should Europe move to disintegration, then that is likely to permanently widen some country risk premia.
To find out more about the future of Europe and its potential to affect markets, download the full paper.