Fear of Trump grips the Eurozone

Key Markets report for Thursday, 14 May 2025

​The euro has been on a tear this year: from January lows of around $1.03, euro soared to almost $1.16 in April. From that level however, it has lost ground, dropping back to $1.12 where it is trading presently. Even though the current correction isn’t quite a trend yet, over the mid- to long-term, the euro could fall back to parity or even lower.

What if the Fed cuts off ECB swap lines?

According to an article published yesterday by Reuters, the supervisors at the European Central Bank are worried about Eurozone banks’ exposure to US dollars and access to dollar liquidity in conditions of stress. Citing three people “familiar with the discussions,” Reuters reported that ECB officials are concerned that under the Trump administration, Eurozone banks’ access to US dollars could be cut.

The Fed has lending facilities in place to provide dollar liquidity for Eurozone banks if required. Although Federal Reserve chairman Jerome Powell reaffirmed Fed’s commitment to maintain dollar swap lines for European banks as recently as April, ECB officials are concerned that this could change in the future. According to the latest figures, as much as 17% of Eurozone banks’ funding is in dollars. These dollar amounts are typically lent to non-bank institutions in the Eurozone for trade financing and other uses.

However, in conditions of stress, those funding sources could dry up, forcing Eurozone banks to resort to the backstop provided through Federal Reserve swap lines. Most recently, this scenario took place in March 2023 when Credit Suisse faced a funding crisis: its creditors withdrew billions of dollars from the bank, and other banks quickly reduced their exposure to Credit Suisse. In response, the Fed provided tens of billions of dollars to the Swiss National Bank, which in turn provided Credit Suisse the liquidity they needed to avert a larger crisis.

The Fed has repeatedly bailed out European banking system: during the 2008 Financial Crisis, it provided a $110 billion swap line for the ECB; during the 2011 Euro crisis, it backstopped Eurozone banks with an unlimited swap line, and during the Covid pandemic it stepped up again with a $159 billion swap line. But if the Fed’s policy changes, the next crisis could be brutal. This could come to pass if, for example, US money markets curtail funding for Eurozone banks (as they did in 2008 and 2011).

All that could go wrong

The resulting scramble for dollar liquidity could cause a sharp rise in EURIBOR and LIBOR funding rates, which would, in turn, cause a dollar refinancing crisis for European companies which depend on US dollar loans. This, in turn, could trigger a seloff of euro-denominated assets to raise cash and buy dollars, leading to further depreciation of the euro.

Should the dollar shortage persist, we could see corporate defaults and bank runs in the Eurozone. The ECB would have to step in to bail out the weak banks, pushing bond yields significantly higher. This could cause many weaker banks across the Eurozone, particularly Italian and Greek banks, to collapse. Ultimately, the ECB could lose control of the situation, leading to hyperinflation if it prints too many euros, or a deflationary depression if it acts too conservatively.

But before failing entirely, the ECB would be likely to reach for the ‘nuclear option’ including capital controls, limiting US dollar outflows and imposing dollar rationing (prioritizing critical imports like energy). Should a crisis like this happen, we would likely also see a sharp political fallout with further rise of eurosceptic political parties across Europe. This will inevitably accelerate the disintegration of the entire EU project along with its fragile currency.

Trump’s power over Europe

A new Eurozone crisis is not yet on the horizon, but it could materialize for a variety of reasons, including the imminent failure of Project Ukraine. After considering the possible effects of such a crisis, it is not difficult to appreciate the power which the US administration holds over the EU's future, its economy and its financial system. For decades, Europe could count on almost unconditional support from the US. Under Trump, this support is evidently no longer taken for granted, which is what prompted ECB action, as highlighted yesterday by Reuters:

A senior executive at one of the biggest lenders in Europe, which is not regulated by the ECB but by other authorities, said their bank is now assigning a 5% risk to a scenario in which Fed financing might not be available, up from zero a few months ago. The person described that level of risk as "quite significant" …

From what we have seen, Trump and his cabinet appear to be outright irritated with their EU “allies” during the past (nearly) four months, suggesting that ECB’s concerns about the future US support are well founded. And as if that weren’t bad enough, the EU and the ECB have been cursed with incompetent leadership like nobody’s ever seen. If a crisis does occur - it’s more a question of when than of if, it will likely escalate quickly and quite bigly.

To learn more about TrendCompass reports please check our main TrendCompass web page. We encourage you to also have a read through our TrendCompass User Manual page. For U.S. investors: an investable, fully managed portfolio based on I-System TrendFollowing is available from our partner advisory (more about it here).

Today’s trading signals

With yesterday’s closing prices we have the following changes for the Key Markets portfolio: