Prospects of European Economy: Defaults, Bankruptcies, and Debt Crisis

Following the emergency meeting, members of the ECB promised to provide all the necessary support to under-pressure eurozone sovereign bonds. On top of that, officials presented a more flexible approach to reinvesting financial instruments accumulated during the pandemic in order to keep the transmission mechanism of monetary policy working.

Does it mean that the risk of fragmentation is gone?

Considering the upcoming rate hike, as well as deteriorating economic conditions,  the answer would be most probably not. Let’s start by saying that the ECB's main task is to ensure price stability and not to provide favorable financing conditions. Keeping spreads low, on the other hand, could lead to so-called monetary financing, whereby government debt (some of it) is bought by the central bank.

Now what?

Last week Christine Lagarde said that keeping borrowing costs under control for more indebted eurozone members is "core" to the regulator's mandate. Fun fact - back in 2020, Lagarde said that it was not the ECB's task to "adjust spreads".

As for the macroeconomic outlook, the region's annual inflation rate is expected to be 6.8% for 2022, 3.5% for 2023, and 2.1% for 2024. Lagarde also warned of the risk of a correction in Europe's financial and housing markets. Who could have thought that the bubble would burst…

In my opinion, things might get way worse than a simple market fall. The reason is very simple - growing social instability in “the old continent”. Over the last few weeks, there have been protests in several EU countries. In particular in Belgium over rising food and petrol prices. In the UK, the transport union RMT calls for wage increases and the avoidance of planned redundancies. Overall, the trend is clear.

Another blow to the EU could be Macron's loss in parliament. For the first time since 1988, a newly elected president has failed to win a majority in parliament. Macron's supporters will now have to negotiate a permanent coalition with the Republicans or forge ad hoc alliances with other political forces to get legislation through parliament. Of course, France is not Germany, still, it is the world's seventh-largest economy by 2022 nominal figures.

Following the debt market.

Talking about the forecast, Fitch Rating's analysts raised their forecast for institutional leveraged loan defaults in the US by 25 bps to 1.5-2% at the end of 2023. Fitch does not rule out that the default rate could rise to 2% or more in 2024 if the challenging economic backdrop leads to a downgrade in corporate ratings. Total loans "of concern" amount to $178.0bn (+8% QoQ).

Most likely, Eurozone will be unable to avoid a technical recession in case the Russian president decides to cut off gas supplies to Europe before the region has managed to replenish storage levels.

Already now, the Euro Area is showing signs of faltering as the tailwind of pent-up demand from the pandemic is already fading, having been offset by the cost of living shock and slumping business and consumer confidence.

Final remarks

In order to understand the perspectives of the European economy, I would recommend looking at what “big investors” do. If rumors don’t lie, hedge fund Bridgewater Associates made a large bet on the fall of European stocks.

To be more precise, the company increased its shorts in ASML Holding and TotalEnergies, BNP Paribas, Vinci, Schneider Electric, Air Liquide in France, Bayer, Munchener Re, Allianz, Vonova, Infineon, Deutsche Börse, and BASF in Germany, Iberdrola, Banco Bilbao and Banco Santander in Spain, ING in the Netherlands and Intesa Sanpaolo in Italy. The moral of the story is? Don't let the market fool you, “headwinds” will only get stronger.