Europe's Lose-Lose Situation

Rising Yields In the U.S. Are Hard To Bear For Europe

The Fed is expected to increase rates by another 0.75 percentage point (or even 1 full percentage point) later this month in response to another high inflation reading from last week. The difference between U.S. rates and those in Europe or Japan will continue to expand.

As a result, the U.S. Dollar might draw more yield-seeking investors and further depress the Euro and the Japanese Yen
Commodities priced in dollars, such as copper and oil, have been hurt by the rising dollar, hurting emerging-market economies whose debt is denominated in dollars and whose servicing costs increase as the value of the dollar rises

High Import Prices And High Debt

With its stronger demographic and economic backbone, the U.S. is, again, in a situation where it can increase rates in order to tame economic activity and preserve social order by having a strong grip on its energy supply (and the price of it). On the other hand, Europe and Japan's model of low inflation, low growth and high debt is failing as inflation keeps rising.

On the political side, some European countries are turning themselves into the poster child of what happens when growth is structurally low, debt rises and social policies take a more important place than economic progress
Europe's gamble could have worked if things went according to the ECB's plan with low inflation being structural and governments being able to grow debt in the face of falling rates
Adding to this, Europe's energy policy and failed attempts at building a new world order resting on commercial ties only are putting itself in a very dire situation

European governments and central banks are now refusing to raise rates and are letting the Euro fall sharply. This leads to further unrest as everyday citizens are now paying for their weak currency through more expensive energy imports.

BENCHMARK'S TAKE

The Eurozone now has to deal with inflation, one of its worst nightmares. At the same time, it needs to push ahead with further inflationary measures such as bringing back home production of certain products (electronics, chips) in order to ensure stable supply chains and its own safety
It thus finds itself in a lose-lose situation where it can elect to let rates low and let its currency fall further or increase rates but cause another sovereign debt crisis
Low rates would reduce the burden on highly indebted governments but shift issues to citizens who have to pay for higher prices and a weak currency
In the medium to long run, this will cause additional unrest and boost hard line right-wing and anti-Eurozone parties forward
Or, it can choose to raise rates and put some countries (e.g. Italy) in a very dire situation
This could lead to a new sovereign debt crisis and further punish the Euro. Leaving consumers with tepid economic activity and a depressed currency, further helping right-wing parties forward

Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

Credits

Photo by Markus Spiske on Unsplash.