By Mike Dolan
LONDON, Oct 2023 – It’s been a grim time for Wall Street with the significant stock selloff erasing almost all gains since the election. The financial trajectory seems precarious, potentially spiraling into a severe downturn unless there’s an uplifting shift in the economic forecast or a clearer stance on U.S. trade policy.
As this unsettling situation unfolds in U.S. markets, I’m turning my attention today to Europe, where the revitalization of defense spending could spur another wave of joint borrowing by EU countries.
Here’s the scoop on Wall Street’s turmoil and other pressing matters.
Today’s Market Highlights
- President Donald Trump’s tariff policies have stirred investor unease, sparking fears of an economic slump that has wiped about $4 trillion off the S&P 500 since its peak last month. Despite these concerns, a top economic adviser to Trump refuted recession speculation tied to tariff uncertainties, even as a household survey showed growing skepticism about the economic outlook.
- In Germany, the Greens are resisting a plan to significantly increase state borrowing for military upgrades, yet they’ve proposed alternative solutions aimed at reaching a compromise.
- Ukrainian President Volodymyr Zelenskiy held discussions with Saudi Crown Prince Mohammed bin Salman before planned talks between Ukrainian and U.S. officials. Washington is hopeful for meaningful progress towards resolving the conflict with Russia.
- In a strategic move to curb China’s dominance in critical mineral production, the Trump administration has proposed building metal refining facilities on military bases, as shared by senior officials.
The Market’s Downturn
Monday was marked by significant losses for U.S. markets. The S&P 500 slumped 2.7%, its biggest drop of the year, breaking below the 200-day moving average for the first time in 2023. The tech sector took a hit, with the Nasdaq falling 4%—a level not seen since 2022. The VIX, a measure of volatility often dubbed the ‘fear index,’ rose to its highest since last August’s yen-related turmoil.
In specific stocks, Tesla’s 15% drop was noteworthy, with its value now over 50% down from December highs.
Adding to the concern is the credit market’s reaction, where high-yield U.S. corporate bond premiums over U.S. Treasuries reached their broadest since September.
Without a clear catalyst for Monday’s steep decline, ongoing trade tariff worries and a weakening jobs market appear to be contributing factors. Trump and his team acknowledge the economic downturn risk as Q1 unfolds.
The New York Fed’s latest consumer survey revealed heightened worry about household finances. The expectation for rising unemployment is now at its highest since September 2023.
Despite the Fed maintaining a steady stance on interest rates, a flight to the safety of Treasuries pushed two-year yields to their lowest since October, while expectations for a 2025 Fed rate cut rose to 85 basis points.
The dollar fell to another 2025 low on Tuesday, and amid major banks downgrading U.S. equity stakes globally, the MSCI all-country index also turned negative for the year.
However, hope flickered as stock futures indicated stability with minor gains starting Tuesday.
A Closer Look at Europe’s Strategic Movements
Are we on the brink of ‘euro defense bonds’? The EU’s latest joint borrowing effort appears to be merely the beginning of what’s needed to secure the continent. This raises the question of whether defense bonds could herald a new era of EU-wide borrowing.
For investors eager to diversify beyond an inward-looking U.S., the emergence of a liquid, triple-A rated supranational sovereign debt market in Europe is compelling.
Expansion beyond the "Next Generation" recovery funds, which total just over €800 billion, could swell this pool to exceed €1 trillion—comparable to heavyweight national debts in Germany, Italy, and France.
Recent backing from European leaders for increased defense spending and support for Ukraine comes in response to President Trump’s shifts in U.S. military and trade alliances. Yet, the proposed €150 billion in EU loans seems insufficient for collective funding needs.
Carsten Nickel from Teneo suggests that merely loosening budget rules for defense wouldn’t suffice, with military spending competing against various domestic priorities.
Eastern European nations may resist the assumption of more defense duties due to geographic vulnerabilities to Russia, thus bolstering demands for joint funding.
Joint borrowing offers a more cost-effective solution. Despite a recent rise in benchmark ten-year EU-wide debt yields to above 3.1%, EU-backed funding still remains cheaper than all but Germany, the Netherlands, and the Nordic EU states.
Nuclear Shelter Concerns
Nickel intriguingly connects the push for joint EU defense spending with France’s proposal for a European “nuclear umbrella.”
“French nuclear protection comes with financial and political strings, especially for Germany,” he noted. “This could allow President Macron to push for EU-wide borrowing, at least for military uses—a political win at home.”
This strategy might also help Germany’s new government overcome objections to shared borrowing. The urgency displayed in Berlin to significantly bolster its own defense budget suggests more EU bonds might be on the horizon.
The primary question is how much additional borrowing will be needed. The EU envisages €500 billion in investments over the next decade, but increasing defense spending to 3% of GDP requires around €200 billion annually.
The Bruegel think tank anticipates short-term defense spending climbing by €250 billion to about 3.5% of GDP, recommending that half of this be funded at the EU level. This could mean selling approximately €625 billion in new EU bonds by 2030.
The Centre for European Reform recently touted the feasibility and benefits of defense bond issuance. They noted that a €500 billion fund would carry an annual interest cost below €20 billion at current yields.
“With everyone sharing responsibility for the debt, it discourages countries from relying on the defense buildup efforts of others, like Poland,” they argued.
Moreover, Europe’s collective debt levels are considerably lower than those in the U.S. and Japan, making EU defense bonds’ triple-A rating seem robust.
The expansion of joint borrowing in the EU might reassure cautious investors worldwide. Military imperatives notwithstanding, if U.S. debt ceiling debates reemerge, steering the American sovereign rating into choppy waters, alternatives could become increasingly attractive.
Chart of the Day
Many had anticipated Trump’s election to spark another stock surge, driven by tax reductions and deregulation. Yet, leading market megacaps have recently undone all gains made post-election, with Tesla notably plunging over 50% from its December zenith.
Key Events to Observe Today
- The U.S. NFIB small business survey for February and January JOLTS job openings
- European Union finance ministers convening in Brussels, attended by ECB Vice President Luis de Guindos
- U.S. Treasury selling $58 billion in three-year notes
Opinions expressed are the author’s own and do not reflect the views of Reuters News, which upholds principles of integrity, independence, and freedom from bias.
(By Mike Dolan; Editing by Anna Szymanski)
