US and Europe Is Decoupling: Defence Shares Up, European Bonds Down

TradingKey – With Trump's unpredictable moves and Europe seeking self-protection, the rift in US-Europe relations has widened recently regarding the peace talks on the Russia-Ukraine conflict. After an emergency meeting of European leaders, expectations have risen that Europe may issue bonds to strengthen its national defense, leading to a surge in defense stocks and a decline in European bonds.

On Monday, February 17, Germany's 10-year bond yields rose by about 7 basis points at one point, reaching 2.50% before closing at 2.483%. Yields on long-term bonds in the UK, France, Italy, and other countries also increased slightly.

Driven by expectations of a peaceful settlement to the Russia-Ukraine issue, European stock markets hit an all-time high. The Aerospace and Defense Index (SXPARO) soared by 4.6%, setting a new record.

The main reason for investors to "sell European bonds and buy defense stocks" is the expectation that Europe will enhance its national defense capabilities by issuing additional bonds. This is triggered by the US handling the Russia-Ukraine issue while bypassing Europe.

Deterioration of US - Europe Relations

The US and Russia will hold peace talks on the Russia-Ukraine issue in Saudi Arabia on February 18. However, Ukraine and European representatives have not been invited to participate.

This has raised concerns about the deterioration of US-Europe relations. A security research expert stated, "Can we still trust the US?"

In response to the US's "overstepping diplomacy," leaders of many European countries held an emergency meeting in Paris on the 17th. According to an informed official, the meeting mainly discussed specific plans to ensure European defense in case the US reduces its involvement and also addressed how to create more leverage for Ukraine.

Europe's Self-Protection and the Decline of Bonds

Jefferies strategists noted that, regardless of the progress of the Russia-Ukraine peace process, Europe clearly needs to increase its defense spending to ensure Ukraine's security.

Plurimi Wealth even warned, "The post-Cold War peace dividend is over, and Europe is likely entering a long-term rearmament cycle with secular growth."

France stated that the EU may jointly issue bonds to finance defense spending. Goldman Sachs expects that the main financing methods could include national debt, existing or planned EU debt, and a lending mechanism established through a new European plan.

In the bond market, against the backdrop of Germany entering a national election and France being governed by a minority government, the rise in benchmark government bond yields is weighing down European bonds.

Promising Defence Stocks

Defense stocks have suddenly become the focus of the European stock market. Rheinmetall soared 14%, Saab AB rose 16.2%, and BAE Systems increased by 8.9%.

Capital Economics stated that European governments are poised to further scale up their plans for defense spending in the coming years, which should benefit the equity prices of European defense companies.

An asset manager predicts that defense stocks are a theme likely to continue gaining momentum. They've already performed well, but he believes they still have room to grow.