Recent data shows significant divergence between the US and eurozone economies. The result has been a depreciation of the euro against the US dollar as the interest rate differential between US and eurozone bonds rises. This reflects the prospect of looser monetary policy from the ECB to counter weakness in the eurozone economy.
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Surfing the Trump wave in the US
Prior to this month’s election, survey data in the US showed a significant spike in uncertainty over the country’s economic prospects. Now, with the result clear and a new Trump administration on the horizon, there is much speculation and enthusiasm in financial markets about the potential for a more business-friendly landscape.
US equity markets have rallied, and some positive economic ‘vibes’ already seem apparent. Recent data showed a big jump higher in the six-month-ahead outlook in the Philadelphia Fed manufacturing survey, while November’s US composite purchasing managers’ index (PMI) surprised, beating market expectations. This was in stark contrast to the deterioration of sentiment in the eurozone (see Exhibit 1).
Eurozone gloom
While US PMIs rose, the eurozone composite PMI fell meaningfully, to 48.1 from 50 in October. The drop was driven primarily by the services PMI, which weakened in all countries. The services sector had been one of the few bright spots in the region.
This data points to downside risks to growth across the eurozone in the last quarter of 2024.
We draw the following conclusions:
- There is an increasingly negative economic impact from concerns over expected US trade policy changes, coupled with political uncertainty in both Germany and France
- The PMI report is consistent with a modest contraction of eurozone GDP in the fourth quarter
- At first glance, the case for a more dovish policy path at the ECB appears stronger. Markets took this view and doubled, to 60%, the probability of a 50bp interest rate cut at the policy meeting on 12 December. In a speech on 22 November, ECB President Christine Lagarde did not comment on the growth prospects or any greater urgency for monetary policy action. However, Vice-President Luis De Guindos said the direction of interest rates was clear, and that it was ‘less important whether the ECB cuts by 25bp or 50bp’ – thus arguably putting both options on the table.
Euro falls to 2-year low against dollar
In the wake of the weak PMI data and amid concerns over new US tariffs on European exports, the euro depreciated significantly, falling to as low as USD 1.033 on 22 November.
It subsequently recovered after the nomination of Scott Bessent as US Treasury Secretary eased investor concerns over president-elect Trump’s trade tariff plans.
Nonetheless, the euro has fallen sharply since the US election over worries that Donald Trump’s plans for broad global tariffs would hit EU growth and encourage the ECB to cut rates more aggressively.
Central bank chiefs sound the alarm
This nervousness over the eurozone’s current economic shape were highlighted in a joint press article by Joachim Nagel and François Villeroy de Galhau, the German and French central bank governors, on 22 November. They warned that US economic policy would confront the eurozone with challenges.
The central bankers noted that ‘Franco-German dialogue is weakened – mainly as a result of the domestic political instability that prevails on both sides of the Rhine. This dialogue is needed now more than ever, as the threats to Europe are significantly increasing.’
On the same day, in a speech entitled “Out of the Comfort Zone: Europe and the New World Order”, ECB President Lagarde stressed the ‘urgency’ of capital markets reform, which had not been ‘matched by tangible progress’ despite rising risks.
She criticised Europe’s ‘extraordinarily fragmented’ financial markets and insisted political leaders should ‘bypass the vested interests that are protected like a fortress in the ancient ages.’
Eurozone bond yields diverge
Eurozone bond yields have fallen sharply against this backdrop. Our view is they have further to fall.
The ECB’s key deposit rate is currently at 3.25% with an implied rate for July 2025 of 1.4%.
Our macroeconomic research team’s analysis is aligned with this view. They see a terminal rate of 1.25% for the deposit rate at the end of 2025.
