In the May 2026 issue of its Financial Stability Review, the European Central Bank puts the blame on Europe’s current and coming economic malaise at the feet of President Donald Trump:
The global financial system and real economy had been remarkably resilient going into 2026, despite a series of uncertainty shocks.
The “shocks” they list are all related to U.S. economic, foreign, and security policies:
questions over Greenland’s sovereignty, the US military intervention in Venezuela, market concerns over central bank independence and renewed trade policy uncertainty after the Supreme Court’s decision to overturn US “reciprocal” tariffs.
In characterizing the global financial system as “resilient” despite these challenges, the ECB review says almost-out-loud that the system would be in excellent shape today, were it not for the fact that President Trump introduced a new U.S. foreign-policy paradigm with his second term in office. The review even makes Trump the explicit threat to financial stability by suggesting that the systemic
resilience is now being tested by a major geoeconomic shock triggered by the war in the Middle East.
Aided by a set of charts, the review puts probability numbers on the risk for financial instability before and after the Iran war.
Altogether, the first seven pages of the report are spent on a lamentation of changing U.S. policy priorities. In reality, very few of these priority changes have had any material impact on the global economy; not even the shift in tariffs policy—which comes with some limited short-term uncertainties—has been strong enough to undermine either the global or the European financial system.
If anything, the intense attention to trade policy and international finance has brought a lot more analytical attention to the financial system. A rise in professional analysis and scrutinizing reviews, together with political and corporate reassessments of everything from trade policy to international finance practices, have been invigorating for global trade and finance.
The fact of the matter is that the global economic system in general, and the financial system in particular, was showing dynamic strength before the war in Iran. That war is the only real adverse event with potential to negatively impact the global financial system, although that impact is moderate and will remain so unless the war explodes in scope and economic disruption.
The ECB review ties this conflict to the financial markets primarily through inflation. It argues that Europe now faces a higher risk of stagflation—a combination of higher inflation, slower economic growth, and rising unemployment. This means elevated interest rates for longer, which would increase loan defaults, disrupt credit supply, etc. Other than that, the review carefully exhausts all its efforts to exaggerate President Trump into a villain behind a destabilization of the European financial system—that has not even happened.
It is not until page 8 in the Financial Stability Review that the ECB gets to the real threat to not just Europe’s financial industry but to the European economy itself. Here, the review admits that markets for sovereign debt
are a central transmission channel through which adverse shocks spill over globally, including to the euro area bond markets. Euro area sovereign bond markets face pressures from rising yields, a changing investor base and external fiscal risk spillovers.
By not bringing up the sovereign debt issue until 8 pages into the report, the ECB has its priorities all wrong. With the exception of a rise in U.S.-bound foreign direct investment, the global issues mentioned by the ECB, from last year’s political repartee over Greenland to the realignment of U.S. tariffs, have had no major material economic or financial consequences.
If there is one factor, though, that could take down the European financial system, it is the slowly rising fragility of EU-domiciled sovereign debt. The years-long European economic stagnation, which I have covered almost ad nauseam and which preceded the 2020 pandemic, has eroded tax revenue and locked millions of wage earners in dependency on welfare-state benefits. A stronger economy would have converted more Europeans from part- or full-time consumers of tax-paid programs to full-time funders of those programs.
In 2024, 19 of the EU’s member states ran budget deficits; in 14 of them, the deficit exceeded the EU statutory limit of 3% of GDP. Over the long term, 10-15 EU member states notoriously run excessive deficits. So long as there is no turnaround in GDP growth across the union, there will be no structural improvement in public finances.
The stagnant nature of the European economy precedes President Trump’s current term by more than a decade. This is a distinctly European problem, and until recognized and treated as such, Europe will remain sorely vulnerable to another sovereign debt crisis. When that crisis erupts, the fallout will be familiar for those who lived through the Great Recession 16 years ago.
A quick look at Eurostat’s database over the composition of sovereign debt reveals a heavily under-reported threat to the European economy. Investors in European government debt are becoming increasingly short-sighted in their portfolio planning—a point noted but ignored by the ECB review. This shortening of the planning horizon means investors are growing worried about over-indebtedness, maybe even defaults.
Three examples:
The shift in Greece is even more representative of how investors shy away from treasury securities with the longest lives. In 2020, 69% of the Greek debt had a maturity beyond 30 years; four years later, that share had fallen to 65.5%. This is not a dramatic shift, but it is a steady trend and consistent with trends in other EU countries.
Not all sovereign debt is undergoing this change, but those that are tend to be the ones with the highest debt ratios or countries that have historically proven to have serious problems with debt containment. This means, bluntly, that investors are concerned about a repetition of the debt crisis of 2008-2010.
But how does this tie over to the financial system? For starters, the interest rate plays a crucial role. When a government suffers a debt crisis, the interest rate on that debt rises sharply and violently. This always destabilizes the financial system by forcing banks to rapidly raise interest rates on their credit. Loans become acutely unaffordable, default rates increase, and banks start taking losses.
In addition, banks are also major owners of government debt. In 2024, financial institutions owned 68% of the government debt in Czechia, 55% in Italy and Malta, and 53% in Spain.
In Greece, the share was only 21%, but it was up from 13% in 2020.
We know very well from the Greek crisis 15 years ago what the banks risk in owning at least some forms of European sovereign debt. Greece underwent a partial debt default, which provided temporary relief for the nation’s taxpayers but gravely eroded the government’s credibility as a debtor.
To be blunt: the stars are quietly aligning for another European sovereign-debt crisis. Investors are seeing this; governments do not seem to do the same. The ECB’s Financial Stability Review says nothing of substance about the severe destabilization threat that comes with financial institutions owning crisis-risk government debt.
If they stopped blaming President Trump for a financial crisis that has not even happened yet, they might prevent an actual crisis from breaking out in the first place.
