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ADVERTISEMENTMarkets have been up and down over the past several weeks, with a level of volatility not seen in a considerable time. Uncertainty breeds volatility, but looking past the noise, one finds Europe in a reasonable position.
Since the start of the year, European stock markets have been outperforming US equities as investors noted the strong relative value compared to the highly priced US markets.
Moreover, European markets are benefiting as governments’ spending plans for increased defence and infrastructure should filter into improved growth.
European consumers, despite expressing confidence concerns in various surveys, have demonstrated resilience in the recent period of high inflation and interest rates. Household savings rates are high across many economies, and employment levels remain stable.
A further growth catalyst could come from the European Commission’s enactment of the Savings and Investment Union, which would channel European savings into support for the expansion of European companies.
Further, the Commission needs to continue rapidly on its path to adjusting internal barriers to trade and investment within Europe, simplifying regulation and focusing on improving trading relationships with other economies.
As the US administration continues its efforts to reposition the global trading environment, financial markets are likely to remain volatile. While the threat of tariffs had been well flagged, the magnitude and breadth of the proposal clearly spooked markets.
The recently announced pause will provide time for countries to negotiate less severe terms, for companies to prepare for the impact on their supply chains, and for investors to fully evaluate their impact.
As for Europe, we expect the tariff issue, if enacted, to impact growth, cutting into a previously improving position. It will be critical for investors to filter out the noise.
There are many questions that remain unanswered and could still impact some firms more severely than others. For example, the largest European sectors with an exposure to trade with the US are the automotive and pharmaceutical sectors.
Wait and see how countries and companies react
If we examine credit markets, we see investors pricing in a rising level of risk, but not yet to a level that would suggest any severe scenarios are on the horizon.
Credit spreads have widened, but so far, only to their five-year historical average levels, not nearly to the wides seen during the pandemic period and the Russian full-scale invasion of Ukraine in early 2022, with its subsequent period of highly elevated energy pricing.
Part of the reason for this is that many European companies have repaired their balance sheets, improved their financing, and adjusted their margins after weathering the recent crises. European banks are also in strong shape, and corporate default rates are relatively low.
As highlighted on KBRA’s Credit Compass podcast, KBRA DLD’s European Index of private credit default expectations are for a default rate of only 1.25% in 2025.
While the severity of the tariff impact could move the needle with respect to these levels, we will have to wait and see how various countries and companies react.
ADVERTISEMENTGordon Kerr is European Macro Strategist at global rating agency KBRA.
