The anti-establishment populist movement is expanding in the EU, and is now centered on Italy. Hungary, Poland, Austria and voters in Germany and Spain are pushing an anti-Brussels agenda, which is also anti-Germany. Italy is in terrible financial shape with a deficit that is now past impossible to rectify. The new government is pushing for a new budget that exceeds the limits set by the EU in Brussels. The new coalition is challenging the EU with a spending plan which is likely going to cause Italian bonds to demand a materially higher yield, and which may be unsalable to anyone other than the ECB. The European banks, and especially the German banks are already full up with Italian sovereign debt, and cannot risk taking any more. Draghi has told Italy that the ECB is not going to bail out Italy if they exceed the budget guidelines, and that would leave a bond yield through the roof, which would create large losses to the European banks holding Italian paper. While the ECB and Germany can cover the crisis in the short term, the ripple effects on the Euro and on bank credit in the EU could potentially be very bad. It is a classic damned if you do, damned if you don't for the ECB. There is even talk of Italexit if things really go off the track.

Merkel is in serious political trouble and it is unclear how much longer she can remain in office. Possibly not much longer. Even if she does manage to stay, she is having to create a new coalition, and she will be in a weak position. She has run the EU for the past decade or more, and if she leaves, the political chaos will be serious. There is no other leader right now who can have the power she had. Complicating things is Brexit, which will come to a head in the next few weeks. If that gets resolved peaceably, it will help calm things a lot, but if it turns into a hard Brexit, things in the EU could get ugly quickly. You might then see a Italexit, or Hungary. We simply do not know what might happen. If we have a hard Brexit, combined with an Italian fight over budgets, and then Hungary and Poland and Austria piling on, things in the EU could turn very chaotic quickly. That is one reason the EU is anxious to resolve the trade issues with Trump, to get that risk off the table. It is also why you should stay away from Europe until thing get more clarity, which may be many months away.

Ramifications are potentially material for the US and CRE. Capital is moving away from the EU, and to the US, as the last safe haven. Emerging markets and China are no place to be investing long term, and probably not even very short term. From there, investors have no place to go other than the US, unless they have a very strong stomach for very high risk. None of this is going away in the short or medium term. The US is very likely to continue to outperform for at least three, and maybe five quarters. Maybe the Fed will only raise in December and March and then pause. A lot also depends on the November elections. The Republicans will hold the Senate and likely pick up 4-5 sets. In the House races, the Republicans are getting a big boost from the Kavanaugh circus the Democrats created, and that is boosted further by Kanye West bringing some black voters over, and the Brunson release which will be helpful in the bible belt states. It is entirely possible since Kavanaugh, that the Republicans hold the House by two or three seats. If not, then things will really get ugly in DC, and it will impact the stock and credit markets and CRE values negatively. All together, this is a very uncertain period, but investments in the EU and emerging markets are now subject to too much risk to make the possible returns worth it even if things go better than expected. So, the US is still the best place long term, and would attract the most capital. Right now is a moment to sit back and wait to see how all this plays out. The Kavanaugh disruptions by the Democrats, and their screaming, out of control protesters, has changed the dynamics materially in the US, and moved the Republicans back to potentially retaining full power, and that will be good for CRE. Strong growth will continue, and the Fed is likely to pause sometime next year. All good things for CRE, but none are for sure. The political crisis in the EU could disrupt everything by early 2019.

The views expressed here are the author's own and not that of ALM's real estate media.

Instant Insights /

The EU Could Become the Real Problem

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