Welcome to Euro fall

After Euro-summer comes the Euro-fall, and we mean that literally. 

On Monday, the euro dropped ~1% (vs USD) to its lowest level in a year and a half. 

That’s not a particularly dramatic timeframe. We’ve held grudges longer than that. We’ve been stuck transiting LAX longer than that. We’ve seen cross-departmental tweet approvals take longer than that.

But it’s the underlying drivers that really piqued 🥐 our interest, starting with… 

1. Spain’s political upheaval 

On Monday, Spain’s (how to describe him…🤔) prime minister put on a grey suit, paired it with a blue tie, and told his nation they’re heading to the polls in November.

It’s another high-stakes gamble for Sánchez, whose wife, brother, and various advisors have now faced probes for alleged influence peddling, while his former transport minister is now doing 24 years (!) for taking kickbacks during Covid!

Sánchez is also still recovering from the Ceuta border crisis, when ~80,000 mostly Moroccan nationals (again) suddenly rushed into Spain’s enclave, itself only home to ~80,000 folks. He eventually apologised to the people of Ceuta, though only after blaming anyone (political rivals, EU partners) other than the Moroccan authorities the migrants themselves said had openly encouraged the dash.

The last straw seems to have been Friday’s failure to pass an emergency housing package amid widespread protests triggered by the forced eviction of an 87-year-old.

So… why call an election? It’s partly a recognition that his position is now untenable, made clear by Friday’s sheer inability to pass legislation (his job). But it’s also a dare for folks to choose between the Sánchez they know, and the conservative opposition that just blocked his popular (if supply-squeezing) housing package.

It might work, too — in addition to framing this election as a referendum on tenant rights, he’s now framing it as Spain’s last chance to halt the hard-right Vox party, which the centre-right opposition will likely need in any coalition government.

Then what’s the euro link? Nothing rattles currency markets quite like Europe’s fourth-largest and fastest-growing economy sliding into political gridlock, amid…

2. France’s fiscal deadlock

France hasn’t posted a balanced budget since 1974, but current talks have become more toxic than a Parisian waiter’s attitude when you misconjugate a verb.

Last week, Macron’s latest prime minister (Lecornu) unveiled an ambitious $60B austerity squeeze aimed at bringing Paris back within EU guardrails. But with the left (“just tax the rich”), the right (“just cut spending”), and the populist-right (“don’t touch working-class pensions”) all equally appalled, his budget is doomed.

Meanwhile, the ✌️student protests✌️ continue. Those sassy air-quotes are because clearly, student and teacher unions are angry at the crumbling buildings and missing teachers, but things have escalated since that initial mid-September spark: it’s hard to believe crowds just torched a firefighter because they want more math teachers.

All the while, France is racing against two clocks. The first is political: just months out from the next presidential election, there’s now no real incentive to compromise.

And the second is economic: France’s budget deficit is projected to increase this year, while its public debt hits a new record of 119% of GDP. And if there’s one thing investors hate more than political upheaval, it’s the associated fiscal indiscipline. 

Which gets us to…

3. Echoes of past crises

Throwbacks are cute when we’re talking about low-rise jeans or film reboots, but less so when it comes to debt crises.

Last week, the risk premiums on bonds issued by heavy debtor countries such as France, Italy, and Belgium (plus beyond the EU, there’s Japan^* ) all spiked. 

While eurozone countries share a currency and interest rate, they don’t share a treasury: each still sells its own bonds, which investors price per each capital’s ability to pay. The gap between (say) a French yield and a German one reflects the extra return investors demand for the risk of parking €100 in Paris, not Berlin.

And that gap (or spread) blew out last week to levels not seen since the 2010-12 crisis, as investors dumped French bonds for German bunds. Other “weaker” EU names (Italy, Belgium) then got hit by a similar trade amid fears the trouble might spread.

So, back to that depreciating euro. 

The European Central Bank (ECB) is now caught in quite the jam:

• ease rates to curb that debt burden, and you risk exacerbating inflation

• hike rates to curb inflation or stabilise your currency, and you risk tipping heavily-indebted members closer towards a sovereign debt death spiral.

The ECB can itself also buy a member’s bonds if the sell-off is disorderly and the capital is behaving, but that brings its own jam:

• step in, and all Berlin hears is monetary financing (printing money)

• stay out, and Rome becomes convinced the ‘backstop’ is just a slogan.

That’s why the ECB’s Christine Lagarde pockets $800k per year to own the eventual decisions, though maybe even $800k looks slim for the headache ahead.

Sound even smarter:

• The euro has depreciated ~5% against the US dollar this year.

• Germany’s Merz and France’s Macron just sent a joint letter to the EU’s von der Leyen urging radical new second strike powers to block distorted imports (from China) and protect European industries (from China). It’s a recognition Europe’s industrial heartlands might be bleeding out faster than the bloc’s decision-making procedures can handle.

• *Japan’s Takaichi has told investors to “rest assured” after her country’s 30-year bond yield hit a new high on concerns around her stimulus plans.