Europe resilient amid turbulence in the US

European markets have rallied despite the slide into correction on Wall Street as economic uncertainty worries investors. Are we on the cusp of a new European dynamic?

In a tale of two markets, the widening gap between European and US equities has topped 15% since the start of the year. European equities are up at least 8%, showing remarkable resilience amid a correction in US markets. United States equities have declined 10% in euro since the start of the year, effectively wiping out all the gains made since Donald Trump was elected in November 2024. The reason? Growing economic uncertainty combined with a significant correction in major tech stocks, as markets take in the recent launch of the new Chinese AI model DeepSeek. Europe, on the other hand, is enjoying favourable tailwinds with the prospects of a more expansionary fiscal policy in the bloc.

Confidence rattled in the United States

Donald Trump’s on-again/off-again tariffs, on Canadian and Mexican goods especially, make America’s trade policy difficult to read, to say the least. Investors are worried that this uncertainty will hurt confidence and ultimately cause a slowdown in the economy or even tip it into recession – a scenario that doesn’t seem to worry the President and his chief economic advisers.

Markets also fear the effects of a tighter fiscal policy. Washington’s very expansionist policy over the past few years helped counterbalance the effects of monetary tightening, but at the cost of worsening public finances. US Treasury Secretary Scott Bessent has called for a “detox period” to shift away from excessive government spending, which will inevitably require cuts in social security programs.

While not yet signalling a sharp slowdown in the US economy, the latest economic data fall short of market expectations, as is clear from the recent movement in the Economic Surprise Indices. In response, markets have adjusted expectations to bet on more significant monetary easing in 2025. Investors are now pricing in three rate cuts by the year end, leading the dollar to weaken against the euro.

Has Europe reawakened?

The threatened withdrawal of US military aid to Ukraine has swept away all doubts around the need for Europe to step up and take structural measures to build military independence. Rising to the challenge, Germany is proposing bold changes to loosen fiscal policy and fund investment, measures that require the approval of a qualified two-thirds majority in the Bundestag.

The incoming government wants to exempt defence spending above 1% of GDP from the “debt brake”, and to set up a special €500bn over 10 years to rebuild the country’s aging infrastructure. This fund would also be exempt from the debt brake rules. The third measure proposed by the incoming chancellor is to allow the 16 Länder to run a deficit of up to 0.35% of GDP, a remarkable move away from the previous fiscal orthodoxy.

Investors have reacted very positively to the proposed measures, which should provide a welcome boost to German and European growth – and to the profits of companies operating in Europe. The announcements have also sent eurozone long-term rates up.

However, this fiscal sea change must be quickly approved and implemented: with European market valuations now close to their historical average, there is little margin for disappointment.

Damien Petit, Sales Director, Private Banking
Banque de Luxembourg