Divergence in US and European economic trends
Economists are penciling in a higher chance of the American economy entering a recessionary period
As we near the end of the first quarter, financial markets have shown considerable volatility. US equities, as measured by the S&P500 index, have declined by 8.78% (as of time of writing) while European equities, measured by the Euro Stoxx 50 index, have rallied by 12.23%.
The disparity in returns has also been seen in the sovereign bond market whereby the US 10-year sovereign bond yield declined by 26 basis points (bp) to 4.31% while the yield on the German 10-year has risen by circa 49bp to its current yield of 2.85%. The spread differential between the two sovereign bonds is the tightest it’s been during the past five years.
The corporate credit market has delivered a mixed performance. Spreads in European Investment Grade corporate bonds have tightened whereas Non-Investment Grade bonds have widened. Both segments of the American credit market have widened thus far this year with the Non-Investment Grade segment of the market having widened by a larger degree than Investment Grade. Furthermore, the US dollar weakened against the euro during these first three months.
The contrasting returns in asset classes between the US and Europe can largely be attributed to different economic expectations which have changed markedly over recent weeks. US economic growth is perceived to be slowing due to tariff impositions while European governments are increasing spending on defence and infrastructure, which has inadvertently fostered growth expectations in the bloc.
The American economy began the year on a strong footing with many touting ‘American exceptionalism’. The strength of the American consumer, as per sentiment and labour market data, provided an economic feel-good factor while the Federal Reserve’s preferred metric for inflation, the Personal Consumption Expenditure Price Index, was showing that inflation was moving towards its target level of around 2% following the aftermath of the pandemic which led to increased prices for goods and services.
However, after President Donald Trump’s inauguration in January, consumer and business sentiment soured as economists are now penciling in a higher chance of the American economy entering a recessionary period at some point this year. This has been brought about by the Trump administration’s imposition of tariffs on imported goods across the board, which will inherently lead to a slowdown in economic activity and an uptick in inflation given the tariff’s effects of higher consumer prices.
Furthermore, the fiscal policies being enacted by the Trump administration have led to a re-pricing of possible rate cuts lower. These factors, and others, have been the main drivers behind the performance seen in both the American equity and bond markets thus far this year.
On this side of the Atlantic, the situation couldn’t be more different. After years of lacklustre economic growth, the bloc, particularly Germany, has initiated plans to substantially ramp up spending on defence programmes. This follows the now infamous meeting between President Trump and President Volodymyr Zelensky, and the indicated intention of the US to play a lesser role in supporting Ukraine.
The fiscal expansionary programmes announced by European governments have now led to expectations of higher expected economic growth which partly explains the rise in equity indices and the higher government bond yields.
In summary, the first quarter of 2025 has witnessed significant market volatility, with contrasting performances between US and European markets. The returns in US equities and sovereign bonds reflect growing concerns over a potential economic slowdown and the implications of trade policies.
In contrast, the performance of European markets is driven by optimism about higher economic growth fuelled by increased government spending. Despite the year-to-date results, the overarching theme for the rest of the year appears to be heightened volatility amid ongoing uncertainty and the various developments that may arise.
Simon Gauci Borda is a fixed income research analyst at Curmi and Partners Ltd.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.