The European Commission proposed on June 19th to open excessive deficit procedures for France, Italy, and five other countries that have accumulated increasing public debt and deficits. The announcement came as so-called far-right parties made major gains in the last European Parliament election, and the French President called a snap election, which has put financial markets on alert.
The purpose of this report is to help decision-makers understand the critical factors that would contribute to an episode of stress in the sovereign debt markets across the euro area. Not our baseline, but the adverse scenario would imply a widening of spreads not always justified by macroeconomic fundamentals and amplified by fluctuations in market sentiment. When this becomes a self-reinforcing dynamic, it can present a risk to financial stability. Hence, the relevance of preparing for tail events in risk management approaches, even though we assign them a very low probability of occurrence.