Is Europe on the brink of a new debt crisis?

Inflation is
slowly approaching the 2% target, allowing the European Central Bank to cut interest rates by 25
basis points and change rhetoric with room for further easing.

This might seem like a positive sign for markets, but French and
German 10-year bond yields remain near 2010 levels when the bloc faced a debt
crisis.

So the question arises: could history repeat itself?

The worst-case scenario does not yet figure in the base case, but
the stakes could rise if the bloc’s economic situation worsens, along with
political tensions.

In particular, if the first round of voting in France this weekend
confirms investors’ fears, the flight of French government debt could
accelerate, affecting the entire EU.

The latter is because France is one of the bloc’s key economies.
Its elimination could diminish the attractiveness of investments in the
eurozone and the euro.

Also working against Europe is that the situation in another
economic powerhouse, Germany, has not been any more
encouraging lately.

Since the beginning of the year, 11,000 companies have gone
bankrupt in Germany, 30% more than in the first half of 2023. This is the worst
figure in a decade.

Things are not going well for individuals either. Due to high
interest rates and inflation far outstripping income growth, personal bankruptcies have
risen by 6.7% to 35,400 cases.

Overall, the situation is not yet catastrophic, but specific
problems could worsen under unfavorable circumstances. And that is exactly what
the markets are pricing in.

Another crucial point to consider is the outflow of capital from
Europe. Against the Russian central bank’s asset freeze, some investors are
moving to new centers, including Dubai.

What to do, or more precisely, what to expect next?

Options markets anticipate increased volatility in European
markets, and bets are growing on a weakening of the USD/EUR as the French
parliamentary elections approach.

What happens next will depend on the results and, above all, the
rhetoric of the leading party. In addition to politics, it is crucial to monitor the economic
calendar.

If inflation resumes its upward trend amid oil price hikes, the
ECB’s likelihood of cutting rates in the coming months will decrease,
supporting the euro but punishing markets.

Moreover, if the U.S. market suffers a correction as a result of
Nvidia’s fall, which caused it to lose some 500 billion in market cap in a few
days, European markets could also suffer a fall.

This article was written by FL Contributors at www.forexlive.com.