Financial markets have not yet fully understood that the euro zone will turn into a war economy

It is likely that the conflict in Ukraine and the crisis with Russia will last and that this will move the euro zone towards being a “war economy”: huge fiscal deficits, high inflation due to the scarcity of many commodities, highly expansionary monetary policy to facilitate the financing of fiscal deficits, highly negative real interest rates to stop debt ratios from rising. We will look to see whether financial markets have factored in this “war economy” scenario in the euro zone: The fall in the equity market does not price in the support for growth that will come from expansionary fiscal policies; Expected inflation still points towards a fairly rapid decline in inflation in 2023; Expected monetary policy remains slightly less expansionary than today; Expected real long-term interest rates are less negative than today. Financial markets therefore do not yet believe the euro zone will become a war economy.