Probability & Partners: A case for Eurobonds
By Rens Borsje, Senior Risk Consultant bij Probability & Partners
In this column, I will make a case for Eurobonds, while trying not to get too much into politics. I will repeat the arguments I have seen and heard, observations others have made, and add some opinions of my own.
The core of the argument is an (upcoming) shift in the market. I believe there is demand, in financial markets, for EUR denominated save high quality assets, while USD denominated treasuries, bonds and equities are starting to look more risky. While I am under no illusion that Eurobonds can replace US treasuries completely or turn the EUR into the reserve currency of the world overnight, I think we can at least make a start.
In my view, the US under the Trump administration is starting to fall apart and financial markets are, at the moment, refusing to accept this. This might be explained by the fact that asset managers, traders, economists and financial professionals are unwilling to believe a large and professional party such as the US government could behave so irrationally.
Historically, US treasuries have been the safe haven for assets for years. I know gold is a safe haven as well, but this asset can be more difficult to fit in a typical portfolio and does not generate any yield intrinsically. Each time there is a flight to safety, because of (economic) turmoil, the yields on US government debt goes down, or at least does not go as high. We even saw this briefly happen after the initial tariff announcement by Trump. This investor behavior has resulted in significant benefit for the US. The Fed and the US government have been able to stimulate the US economy out of economic crises more quickly and more cheaply than the rest of the world, without significant currency devaluation and inflation.
Similarly, there is the belief that holding dollar assets has no downside. If the world/global economy does well, then the US benefits the most, and if there is trouble there is a flight to safety, i.e. people will sell risky assets and buy USD denominated equity and treasuries.
The key reason Trump decided to put a pause on the announced tariffs were the ‘Yippy’ financial markets. Treasury yields were shooting up quickly as investors were starting to price in an economic slowdown and trade war with the US at its center. I commend the levelheadedness of the Fed. They were able to resist intervening until Trump himself announced the pause. Note that there was an almost jointly timed statement by the Fed and the ECB afterwards. Both central banks were ready and able to step in if needed.
At the moment, the Fed seems to be the last bastion of resistance against the Trump administration, although Trump is not afraid to openly bully Powell or threaten to try and remove him. Note that his term as chairman ends a year from now in May 2026. The upcoming meeting will no doubt be another source of disagreement between the Fed and Trump. As the president is actively tweeting for lower rates tomorrow given the positive job number surprise (a statement that is difficult to follow using classical economics), I don’t expect the Fed to cave in in this game of chicken and lower rates at this moment.
Looking at what Trump has achieved in his first 100 days in office does not bode well for the (economic) stability in the US. The Trump administration, to put it mildly, has proved to be unconventional and does not adhere to classic economic theory. The efforts of the DOGE department, the hardening of the political landscape, the increasing social inequality, the pressure applied to law firms, the disregard for legal rulings, and the fickleness of the tariffs have shown me the unreliability of the current administration. The headlines we have seen over the past months could easily be mistaken for those of a third world country under questionable leadership. I believe the market is still not pricing in the credit risk associated with the US government.
Looking at the greenback: the dollar is depreciating both intentionally and arguably unintentionally by Trump. Intentionally, to help exports, and unintentionally as a result of the rest of his actions. I believe there is much more room for the dollar to weaken. In my eyes, the market wisdom that holding dollar assets has no downside is no longer true. The US is not well positioned to benefit from a potential economic boon, nor does it look like a particular safe haven if a full-blown economic crisis were to start now. If you don’t believe me, just heed the warning of Warren Buffet:
‘We would not really invest in a currency that is going to ‘hell’’
What’s next for Trump? The idea of re-negotiating outstanding treasuries or downright reducing the interest paid by the US government has been floated a few times now. This would have been unthought of before this year. I believe Trump sees this as a potential negotiating strategy as he holds the view that the world needs to pay for dollar stability. In my view, almost the opposite is true. These types of discussions and threats will further drive volatility and weaken US treasuries.
The underperformance of US equities and Treasuries has been a double whammy for non-US investors as the EUR (or other local currency) value of these holdings has taken a double hit due to the FX effect in both performance and volatility. Investors are, and should in my opinion, reassess their asset and risk allocation to the US. The effects of this are already observable. Germany has seen lower bond yields (and spread versus Euribor) despite opening the door for fiscal easing for themselves and the rest of the EU to fund increased defense spending.
As the hegemony of the US is starting to shift, there is room for divergence between the US and the EU, both in economic and social ideological terms. The EU inflation expectations are lower compared to the US, and the EUR currency is stronger.
I realize that so far, I have spent most of this column highlighting risks in the US instead of making a case in favor of Eurobonds. Additionally, I am aware of practical issues to be addressed such as how the raised funds are distributed and how the guarantees for the different governments should work. Should Germany (and relevant for us, the Netherlands), become a guarantor for Greece, Italy and Spain? Probably not. However, I am sure a legal solution in the form of a weighted guarantee, waterfall or something can be found.
Despite the hurdles to be overcome, I believe just the existence of pool of high-quality EUR denominated bonds creates demand and therefore might even reduce the cost of funding for European governments. We should start building up this pool sooner rather than later, so we can start to take some of the benefits the US have been reaping from the roughly 30 trillion USD treasury markets for ourselves.
