Be warned, a full-blooded European sovereign debt crisis is coming

Welcome to the age of divergence! A new long-term trend is upon us. Buy Dollars, Sell Europe. Unfortunately, it’s likely to play into Putin’s hands in Ukraine.

Hurts to say it, but Europe is going to struggle most with what’s coming next. It’s got limited choices between galloping inflation, economic misery, and political instability. Being Europe, there is a significant risk it’s likely to reap the non-benefits of all three.

After the US and UK hiked interest rates this week, the global inflation threat is so pronounced that even the Swiss National Bank surprised markets by joining the central bank tightening trend. The Bank of Japan – well, they have a different view, keeping up QE and zero interest rates, but they have a different demography, and a tumbling yen that doesn’t particularly bother them.

Thus far, central banks are struggling in this crisis. Addressing the massive exogenous inflation shock of the Ukraine war, following the exogenous shock of the pandemic with 50 basis point rate hikes, feels like treating a gaping flesh wound with a kid’s sticky plaster. It isn’t going to stop inflation. The Bank of England is now predicting Q3 inflation of 11% and raising interest rates is a massive problem for markets.

Reading through acres of market research, the credibility of central banks is being called into question around the globe. They face a devil or the deep blue sea choice – how to a) preserve jobs and economic stability by avoiding a market crash, or b) slash inflation? And/or is not an option. It’s a thankless task, made more complex by the consequences of the last 13 years of monetary experimentation.

The ECB? It exists in the same economic world as the rest of us. But being a committee of 19 national members makes it somewhat unwieldy. At the best of times, steering an economy with imprecise monetary tools is challenging. For the ECB, it’s a compromise at best. That’s a major reason that 10 years after the last European Sovereign Debt Crisis, absolutely nothing is fixed about the debt-raddled south.

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