In the bustling world of European finance, the latest trends suggest a persistent pressure on equity markets, primarily influenced by trade tariffs and political turbulence. The situation presents a stark contrast to major global markets, highlighting Europe's unique challenges. Over the past week, the three prominent indices in Europe demonstrated a mixed performance, reflecting this ongoing struggle.
Specifically, the German DAX 30 index recorded a modest gain of 1.57%, while the UK's FTSE 100 saw a slight increase of 0.24%. Conversely, the French CAC 40 index suffered a decline of 0.29%, indicative of the budget crisis weighing heavily on the French market. This disconnect between nations illustrates the intricate dynamics shaping the European financial landscape.
Currency fluctuations also paint a complex picture. After enduring three consecutive weeks of declines, the euro managed to reverse its fortunes last week, appreciating by 1.52% against the dollar. Analysts from HSBC suggest this upswing might be temporary, forecasting the euro could stabilize around the 1.05 mark by year's end. However, looking ahead to 2025, they remain bearish on the euro, predicting it could dip below parity with the dollar due to underlying economic pressures.
Significantly, the inflation data released last week will likely impact the European Central Bank's (ECB) potential interest rate decisions in December. After two months of decline, inflation in November rebounded, surpassing the ECB's target of 2%. Yet, the ECB had already prepared markets for this outcome, resulting in no significant reaction upon the release of the data. The prevailing market sentiment suggests that a rate cut this month is nearly a certainty.
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The discussion around the magnitude of possible rate cuts, however, remains contentious. Market expectations lean towards a 25 basis point reduction, yet dovish committee members, alongside institutions like Capital Economics and JP Morgan, advocate for potentially larger cuts by the ECB in December. This week, all eyes will be on ECB President Christine Lagarde's testimony before the European Parliament’s Economic and Monetary Affairs Committee, where insights into further rate cuts may be revealed.
Meanwhile, the U.S. Thanksgiving holiday provided a brief respite for technology stocks, which surged after the holiday, pushing general market indices upward. The STOXX 600 index in Europe increased by 0.35% this past week, marking a return to gains after a series of declines in recent months. Furthermore, the tech sector index (SX8P) had a stellar week, climbing 1.6% amid favorable news about U.S. export controls, indicating a possible softening of regulatory pressures impacting European semiconductor firms like ASML and Infineon.
In stark contrast, sectors such as automotive, energy, and banking experienced setbacks. The automotive sector, rattled by tariff threats and the deteriorating U.S.-China trade relationship, witnessed a 0.73% drop. The energy sector also faltered, declining by 1.9% due to falling crude oil prices. Additionally, the banking sector faced pressures as political uncertainty in France prompted a decline of 0.4%. This fragmentation within European markets has become a focal point of investor scrutiny, especially when juxtaposed with the robust performance of the S&P 500, which gained approximately 7% over the past three months, while the STOXX 600 fell by around 2.5%.
The complexities plaguing the European stock markets were underscored last week when Mabrouk Chetouane, Chief Global Market Strategist at Banque Française de Commerce Extérieur, articulated concerns regarding the high level of uncertainty influencing investor sentiments. His commentary pointed towards tariffs and the political instability in France and Germany as significant sources of worry for market participants.
Goldman Sachs recently revised its profitability outlook for European stocks through 2025, advising investors to preferentially allocate their assets towards American and Asian markets, particularly Japan, while maintaining a neutral stance on Europe. Such assessments reveal a broader skepticism about Europe's economic prospects, further highlighted by the recent capital outflow trends. According to EPFR's tracking data, American equity funds saw an influx of approximately $441 billion in new capital, while European funds recorded an outflow of $56 billion thus far this year.
Despite these challenges, Bank of America has taken a contrarian position, upgrading its rating for European stocks from neutral to buy, citing that major European indices are experiencing the worst performance relative to the U.S. since 1976. Sebastian Raedler, Head of European Equity Strategy at Bank of America, argues that improved fiscal spending space in Europe, alongside the possibility of a ceasefire in Ukraine, could alleviate some inflationary pressures that have been mounting from soaring energy prices. This perspective suggests a tactical upward potential for European equities relative to the broader global market.
The ongoing deliberation within the ECB regarding the extent of potential interest rate cuts remains a critical issue. Last Friday evening, Eurostat reported that the eurozone's CPI for November slightly rebounded to 2.3%, exceeding the ECB's target yet still falling marginally short of expectations for core CPI. ECB Vice President Luis de Guindos remarked that this inflation data was relatively encouraging, albeit anticipated.
Analysts like Bai Xue from Dongfang Jincheng offered insights into the inflationary trends, suggesting that the uptick was driven by reduced falls in energy prices and suggestive of underlying pressures rather than a rebound in inflation itself. They maintain that the broader trajectory suggests continued downward pressure on inflation expected for 2025, alongside improvements in labor markets, with risks of deflation remaining low.
Despite the recent rises in inflation rates exceeding the central bank's targets, sentiments across the market indicate that these factors are unlikely to prevent the ECB from continuing its rate-cutting measures, with a third consecutive reduction anticipated this month. The current deposit rate stands at 3.25%, with suggestions that the ECB may need to reduce rates below neutral to stimulate economic activity, albeit risking renewed inflationary pressures.
Internal debates within the ECB reflect disagreements regarding the pace and depth of rate cuts. Last week, ECB council member Schnabel cautioned against excessive reductions due to potential over-expansion, while members such as Villeroy and Stournaras leaned slightly towards stimulative measures, suggesting that cuts exceeding 50 basis points shouldn’t be dismissed entirely.
As markets continue to react, a prediction from the money markets indicated a mere 13% probability of a 50 basis point cut, while a 25 basis point reduction seemed almost fully priced in. Bai Xue added that given the November inflation data marginally exceeding expectations alongside positive GDP growth in the eurozone, larger cuts seem less probable, making a 25 basis point cut more likely.
Looking ahead, the trajectory of rate cuts may reflect the broader global economic environment. Wei Xue anticipates that with waning domestic demand and weakened external demand, the eurozone's growth potential will likely diminish. Additionally, the reported contraction of services coupled with a deepening decline in manufacturing indicates a concerning forecast for business activities in the coming months. The persistence of low inflationary trends will likely shape the ECB's decisions as it aims to balance growth risks moving forward, suggesting a gradual easing of interest rates likely amounting to about 100 to 120 basis points from now until mid-next year.
However, external factors such as trade tariffs could significantly influence the ECB's path, as tightening imposed tariff policies may further strain European exports, intensifying economic headwinds and possibly compelling a more aggressive stance on interest rate reductions.