I finally took a look at the Deutsche note that prompted Chief Executive Officer Christian Sewing to distance himself from the research (supposedly in a bid to pacify Scott Bessent).
Turns out, I had the note the whole time. I missed it because it was hiding in plain sight as one of the daily missives sent out by Deutsche’s FX strategist George Saravelos. Forgive me, there’s a lot going on!
Here’s the full note, which was originally sent out on Jan 18:
This weekend President Trump renewed trade threats on Europe with the aim of acquiring Greenland. We are not so sure the impact on the euro will be as negative as is commonly assumed.
Europe owns Greenland, it also owns a lot of Treasuries. We spent most of last year arguing that for all its military and economic strength, the US has one key weakness: it relies on others to pay its bills via large external deficits. Europe, on the other hand, is America’s largest lender: European countries own $8 trillion of US bonds and equities, almost twice as much as the rest of the world combined. In an environment where the geoeconomic stability of the western alliance is being disrupted existentially, it is not clear why Europeans would be as willing to play this part. Danish pension funds were one of the first to repatriate money and reduce their dollar exposure this time last year. With USD exposure still very elevated across Europe, developments over the last few days have potential to further encourage dollar rebalancing.
Remember the Munich Security Conference. It was the US Vice President’s Munich speech last year that proved the proxy catalyst for an acceleration in European defence spending. Could it be Greenland this year that catalyses an acceleration in European political cohesion? It is notable that the two leaders of the euro-sceptic far-right parties in Germany and France have been highly critical of recent developments. The extent to which a unified European strategy arises over the next few days to address US pressure will be a key near-term signal. Either way, we have sympathy with longer-term arguments that the US approach may be increasing the prospects of longer-term European political cohesion.
Putting the two together, we are not convinced any negative EUR/USD reaction will be sustained this week. We are also not convinced of any impact on EUR/DKK, see our extensive report on the Danish krone.
Beyond FX, it is reasonable to assume that the EU thinks it holds some leverage given the upcoming US midterms. The administration is focused on bringing inflation and treasury yields down and Europe may be able to influence both. From our perspective the key thing to watch over the next few days will be whether the EU decides to activate its anti-coercion instrument by putting measures that impact capital markets on the table. With the US net international investment position at record negative extremes, the mutual inter-dependence of European-US financial markets has never been higher. It is a weaponization of capital rather than trade flows that would by far be the most disruptive to markets.
There are three quick observations to make, some of which I already expressed on X.
- Saravelos is a very smart man who has a very good grasp of what FX markets need to be aware of on a daily basis. I’ve followed his work for a long time, and really rate his stuff. Even so, I’ve never personally witnessed him express much expertise about the finer workings of the repo market. Or, for that matter, about how global capital flows influence domestic payments infrastructure. I could be wrong here, of course. But my hunch is that Saravelos is largely a generalist. He offers important views about the big picture, but may be in the dark about the second-order effects of using Europe’s Treasury stock against America. The other reads more like a flippant take that failed to appreciate the wider sensitivities and implications of such actions. These, of course, relate to the fact that Europe would quickly find itself in deep trouble with respect to honoring its USD liabilities if it started selling off Treasuries — the very scenario that triggered the 2008 crisis.
- If you read the text carefully, the true assertion isn’t that Europe’s power lies in dumping existing USTs, but rather in initiating a buyer’s strike. Consequential, but less impactful as a coercion strategy, not least because the U.S. can compensate for that flow with stablecoins. Besides, as the Government shutdown grips Washington, we’re reaching the limits of how much new supply Congress will even approve, especially for military spending in the wake of all the ICE controversy.
- Bessent/Warsh cutting Europe off from swap lines is a nuclear option. It would represent an irreversible rupture in the Europe/US relationship and a significant financial crisis for European banks. French banks in particular are very exposed. As are all the British banks operating out of the U.K. offshore system. As was pointed out to me, the BIS’s list of globally systemically important banks has evolved significantly since the GFC. It’s gone from a diverse list of British, German, Swiss and French banks to a list that today includes only four French banks. The world’s most connected banks today, meanwhile, are considered to be Deutsche Bank, HSBC, which takes the top spot, followed swiftly by BNP Paribas.If these banks lose access to swap lines because European institutions decide (on the back of political pressure) to do something stupid like sell off all their USTs, the chaos will be significant. Of course, if the U.S. were the first mover — cutting off swap lines from Europe for its own political reasons — institutions would be forced to sell USTs to raise liquidity to meet liabilities regardless.I suspect in that case, it would serve European powers well to maintain face domestically by presenting any fallout as the necessary cost of taking a principled stance against an increasingly fascist and authoritarian America. Not because they’ve been ejected from the system for failing to fall in line.
