Transcript: European equities rise on plans for stimulus spending, peace talks

Changing spending plans

LM: In recent weeks there have been significant announcements by the German government to increase fiscal stimulus over the next couple of years. In total, over the next 12 years, you’re going to see an increase in fiscal spending in Germany of over 1 trillion euros. We’ve also seen additional fiscal measures being announced in Europe. So the E.U. is basically easing the fiscal rules whereby countries now, over the next four years, are allowed to increase spending on defence by about 800 billion, and this will be funded by a loan facility of about 150 billion euros and up to 650 billion of domestic issuance. It’s probably going to be 2026, before we see a real impact on growth, but in coming years, it’ll add about 1% to German growth, pushing growth to about 1.5% to 2% over the next 10 years per annum. In terms of European growth, the impact is less. It’ll add about 0.3% to European growth over the next three to four years.

Rates and currency

LM: The ECB has cut deposit rates already by 150 basis points, down to 2.5%. Now the expectation was that we would see another 75 basis points of cuts from the ECB over the remainder of this year, really driven by the fact that inflation is expected to continue to fall. However, given the improved growth prospects, the market has basically taken out one rate cut from the ECB and is now expecting only 50 basis points of further cuts over the remainder of this year. In terms of other asset areas, the euro has responded positively to this more-coordinated policy response, more integrated Europe, and again, on the back of better growth prospects, fewer rate cuts. Euro:dollar has risen from a trading range of about 102 to 105 at the start of this year, to 109 currently. When we look at bonds in Europe, in contrast to what we’ve seen in the States where yields have fallen on the back of increasing growth concerns, again, post this announcement, what we’ve seen is German and European yields have risen by about 50 basis points year to date, with the German 10-year yield up to about 2.85% currently.

Implications of tariffs

LM: The U.S. administration has focused more and more on the trade deficit with Europe, and the scale of tariff threats have significantly risen compared to where they were through the election campaign. Now Europe is vulnerable to a number of sector-specific tariffs, such as the 25% tariff already imposed on steel and aluminum. There are further 25% tariffs threatened on the auto sector, pharma and semiconductor goods. And Trump has proposed 200% tariffs on champagne and alcoholic imports. Europe is quite vulnerable to reciprocal tariffs. Now pure reciprocal tariffs, in terms of like-for-like tariffs, wouldn’t have a huge impact on Europe. However, Trump has suggested that account will be taken of non-tariff barriers, including things like VAT differences. Now average VAT rates in Europe are around 20%, compared to an average sales tax in the States of about 5%. So if this difference is included in the tariffs when they’re set, Europe could see significantly further higher tariffs being implemented. In a worst-case scenario, if that were to happen, the drag on European growth could be close to 1%.

And finally, what investors should keep in mind

LM: So when we look at European bonds, we’ve seen a big rise in yields already. In absolute terms, yields are up 50 basis points year to date in Germany, versus the U.S. [where] 10-year spreads are up about 75 basis points year to date. We think these types of increases already fully reflect that increased fiscal stimulus and increased issuance that you’re going to see in Europe and Germany over the next couple of years. It does feel that the increased fiscal expansion is now fully priced in. And when we look at the over-five-year benchmark in Europe, it currently gives you a yield or carry of 3.4%, which is quite attractive. But, again, with some scope for yields to fall, we believe across Europe, as the ECB continues to cut rates, we think you can get mid single digit at least in terms of returns from European bonds over the course of the next 12 months. In terms of equities, equities have actually performed quite well year to date. European equities still trade at a wider-than-average discount versus U.S. equities of about 10% currently — although the gap has obviously closed significantly. Short-term performance in Europe, I think, will be determined by tariff announcements from the States in early April. Again, if they’re very severe, you could see a short-term correction in European equities. In terms of the longer-term outlook for European equities, the structural outlook has definitely improved. Europe is now in a much better position to be able to at least match or be close to the performance of the States. To see sustained outperformance from Europe, I think you need to see additional reforms coming through.

Well, those are today’s Soundbites brought to you by Investment Executive and powered by Canada Life. Our thanks again to Lenny McLoughlin of Irish Life investment managers. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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