Blain’s Morning Porridge June 24^th 2024: Europe’s Fragile Bond markets could be the spark for the next conflagration.

“These days are past now, and in the past they must remain…”

Watch the bond markets! In bonds there is truth. The current political ructions across Europe highlight the fragility of Europe’s cobbled together bond markets. If they break, the outlook for markets will be… interesting (and not in a good way.)

Hope is never a sound strategy, but nearly 2% of the Scottish population travelled to Stuttgart last night for the Football. Only a small fraction would have got into the actual stadium to see our team lose 1-0 to Hungary – the death-knell of yet another fantabulous hope of unlikely footie success. Ach well… we can dream and there is always a next time….

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She-who-is-Mrs-Blain and I spent last week sailing around the wonderful Saronic Islands to the South of Athens. After the financial crisis of 2008 and the subsequent meltdown in Greek debt which led to the economy contracting some 30%, there is clear economic recovery underway in Greece. On each of the famous islands like Hydra, Spetses and Poros, buildings were being renovated and restaurants upgraded. Everywhere we went were large private yachts with their retinues of staff catering to the whims of charterers and owners. There were literally hundreds of smaller charter yachts competing for moorings (but frankly not the skills for them all to be sailed well.) We had to get well off the travelled seaways to find peace and quiet – which we did on the Peloponnese mainland.

We’d picked the early summer for our trip, hoping to avoid the heat, the crowds and wildfires. Yet the temperatures were already climbing towards the 40s, while a strong “Meltemi” blew for 3 of our days. We watched the near-gale shred other boats’ sails as big waves broke over our catamaran. One night we anchored in a quiet bay on one of the Islands, but a large luxury charter boat then moored up and fired off a firework display that would not be out of place at the Olympics. When we got back to the UK on Sunday I read how a firework display set off wind-driven wild-fires on Hydra, killing at least one person – the very same evening!

Enough of what I did on my holidays… sailing gave me a chance to recharge and think about the global economy…. I am…. Concerned.

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Is it just me, or does this market feel out of kilter? Something wicked this way comes, and I suspect its hiding in the bond markets.

There is lots of talk the US is now heading into recession, yet the US stock market hit yet another tortured record level creating wealth and abundance for those with Nvidia in their portfolios! No other stock matters – the analysts are trying to figure out exactly what Nvidia might be worth in the future – no one really knows, so the default answer is apparently “lots”.

Meanwhile, the Western World looks to headed for political instability and crisis. The reason is simple – although I seldom see it written in research or commentary:

Rising Inequality.

Across Europe, the UK, and in MAGA USA, the overriding political theme is a lurch towards the right by the vast numbers of workers who never had the savings to have participated in the financial asset boom which looks to be culminating in Nividia Euphoria. In contrast to the wealthy, they have seen their standard of living crash since pre 2008, and feel increasingly left behind. Well-scripted political opportunists like Le Pen, Meloni, Farage and Trump have played upon and magnified voter fears about immigration, jobs and unfair foreign competition, and are set to reap their returns at the ballot box.

The latest polls show the unhappy French electorate believe the Far Right Rassemblement National under Marine Le Pen will prove more competent with money, deliver jobs and stabilise the economy better than the moderate, technocrats of whatever Macron’s centrists are calling themselves now (Ensemble since you ask). It’s taken Le Pen decades to make her message respectable, but it is resonating because voters believe they have been left behind, buried by uncaring wokist state bureaucracy that’s happily sold them out for cheap Chinese exports, immigrants and the Islamification of their society.

Markets fear a French bond meltdown on the back of unfunded and uncosted RN electoral promises – a threat that could seriously roil not only the French OAT market, but expose and undermine the whole European Sovereign Debt market. Gosh, but we’ve been here before. I bet I could simply recycle what I wrote about the last European sovereign debt market crisis 2009-2011. Essentially little is fixed.

French bonds are not a sovereign debt market like Gilts in the UK, US Treasuries or Japanese JGBs. That is because France does not control its own currency. It can’t simply press go to print money to repay debt. France surrendered its financial sovereignty to the ECB and the Euro. Although France can issue and borrow more OATs, it needs to meet the rules and secure the approval of the ECB to do so, and should France find itself struggling to repay, it will need the ECB to allow the printing of Euros.

There is a subtle but critical difference between a financially Sovereign state and a Sovereign credit. Generally the history of nations going bust is the lesson: “don’t borrow in anyone else’s currency.” Ask the Argentinians how well that worked for them.

Thus far the history of the ECB and the Euro is a succession of “whatever it takes” fudges to create a mythos of Euro bond market stability – doling out money to banks to buy sov debt, turning a blind eye to breaches of the stability rules, or effectively breaking Greece to restore the illusion of the Euro’s stability. It’s been enabled by the expectation Europe will move from the monetary union of the Euro towards a single European monetary, fiscal and political union. Not so any longer….

The problem of Euro member’s imperfect and conflicted financial sovereignty lies at the heart of a renewed potential European sovereign debt crisis later this year if markets reject new French borrowing. Right wing parties all want to spend Europe’s money to pay their domestic voters. It’s happening in Italy, now France, and as the polls show will also happen in Germany. If one nation free-rides the rules it’s a crisis – when three of the big European states are demonstrating their naked self-interest ahead of the EU, then just how sustainable is the Euro and Europe’s debt?

My Virtuous Sovereign Trinity theory is exceedingly simple – a nation with a stable currency, a sustainable bond market and political competency will generally succeed, but if any leg breaks in terms of bad politics, a currency collapse or the bond market in turmoil, then crisis is inevitable.

In Europe the EU attempted to bypass national bond markets by issuing Next Generation pandemic support bonds which the EU would disburse to member nations, effectively by-passing domestic issuance, ultimately negating all the heartache of Bund/BTP/OAT/Bono spreads and the inference of a disunited non-fiscally unified Europe. It would give Brussels the power to check any nation’s political competency to use the Euro bond markets – which is why every right-wing European party is opposed to further moves towards political union, and many would prefer to exit.

The political competency of Europe and the Euro to withstand a breakdown in its multiple domestic bond markets if money flees Europe into financially sovereign instruments like Gilts and Treasuries should not be under-estimated. With the US likely to be experiencing its own wobbles come November, could that leave Gilts in a favoured space?

Curiously, for once no one seems remotely bothered by the UK election – Labour have convinced business and the City they will be better Tories than the Tories and strict budgets will be maintained with all polities costed and fully funded. Labour will be hoping their apparent political competency will give them the ability to borrow more to start the repair of busted UK. However, if a European bond meltdown is followed by increasing crisis in the US markets, then general market mayhem may yet come to pass!

Watch the bond markets like a hawk in coming weeks.

Anyone want to take a bet on how many Tories broke the law by using privileged insider information to place bets on a July election? I am hearing 30+ Politically Exposed Persons (PEP) names are in the frame, names which will leak out daily ahead of election day. You have to ask how they could be so silly…

Out of time, off to catch up on emails and the day job…

Bill Blain

Author of the Morning Porridge

Wind Shift Capital