Transatlantic divergence of growth continues for now
The US economy remains robust despite growing headwinds, while Europe’s economy is more heavily affected by the war in Ukraine. This gives the US Federal Reserve more scope for action than the European Central Bank. Yields seem set to remain on an upward trajectory for now.
Headlines such as “Purchasing managers’ indices in the eurozone stronger than expected” and “Solid news from the US construction sector in March” confirm that recent economic data does not suggest any immediate danger of an economic slump on either side of the Atlantic, despite the adverse influence of the war in Ukraine. However, it is worth taking a closer look, as differences in the pace of growth are increasing.
Closer economic ties with Russia, greater geographic proximity and the higher dependency of some European economies on energy imports from Russia mean that economic growth in Europe is suffering more as a result of the war in Ukraine than growth in the US. The steep rise in gas prices in Europe is affecting many countries. Germany consumes substantial quantities of gas due to its large industrial sector and has thus been hit particularly hard. This is also dampening consumer sentiment. For investors based in Germany, it is little consolation that the US economy is in a much more robust shape, and has been for a while, putting the country on a stronger economic footing.
Figures for US gross domestic product (GDP) for the first quarter of 2022, which will be published on Thursday (28 April), should confirm this. By contrast, eurozone GDP data, which will be published the following day (29 April), is unlikely to make for pleasant reading. Europe’s saving grace will probably be year-on-year effects: In the first quarter of 2021, the European economy was still much more impacted by the coronavirus pandemic than the US economy. The war in Ukraine means that conditions in Europe have remained dampened. An economic slump is not expected, but stagnation seems a realistic scenario, provided that Russia does not completely suspend its supply of oil and gas to Europe.
Growth differential likely to narrow in 2023
In the near term, the divergence of economic growth east and west of the Atlantic will therefore increase further. The US economy had already returned to its pre-pandemic shape by the end of the second quarter of 2021. Economic output in the eurozone was almost back at pre-crisis levels at the end of 2021. But for Germany, the laggard in this race, Union Investment’s economists predict that the economy will not recover to its pre-pandemic condition until the fourth quarter of this year. The differences in momentum will thus remain quite stark in the current year. Our experts predict growth of 3.1 per cent for the US economy and 2.5 per cent for the eurozone economy. By contrast, the German economy is expected to grow by just 1.6 per cent.
Transatlantic divergence of growth persists for now
Year-on-year change in real GDP
However, in 2023, the divergence in terms of growth is expected to diminish again somewhat, provided that the war in Ukraine does not escalate further. Union Investment’s economists believe that economic growth in the US will slow down to 1.9 per cent, partly due to interest-rate increases by the Fed, while the eurozone’s GDP and Germany’s GDP are each expected to grow by 2.1 per cent. This also shows that the negative influences on growth in the baseline scenario for Europe are not severe enough to choke off economic growth entirely.
What matters most for the capital markets are differences in the quality of growth and in inflation trends. From this perspective, scope for monetary policy action is much more limited in the eurozone than in the US, where generous fiscal measures under the American Rescue Plan have helped the economy to return to its pre-pandemic growth path. Disposable income will remain stable thanks to the solid labour market and an upward trend in wages and salaries (especially at lower income levels). This means that consumer spending should remain supported even though households are no longer receiving government transfer payments.
Fed takes action to bring down inflation
On this basis, the US Federal Reserve (Fed) is able to take a more robust approach to fighting inflation than the European Central Bank (ECB). It benefits from the fact that the US housing market, which plays an important role in this context, is less sensitive to interest-rate increases than it used to be, because a large proportion of mortgages now have a fixed interest rate rather than a variable rate. So far, no tangible slowdown has materialised in the construction sector as a result of interest-rate hikes. The difference in the nature of inflation in the US also makes things easier for the Fed. The turbocharged reopening of the economy after the coronavirus pandemic initially created an imbalance between supply and demand in the US, which fuelled inflation. Demand-driven inflation is easier to control through monetary policy, because the central bank can take steps to slow down demand, whereas it has little influence on rising commodity prices.
US gas prices have recently risen significantly in expectation of higher exports of liquefied petroleum gas from the US to Europe, where countries are looking for alternatives to gas imports from Russia. The Fed’s signals have been very clear: It is serious about planned steps to bring down inflation. It wants to swiftly transition to a neutral base rate that does not drive growth. However, Union Investment’s economists believe that the expectations for interest-rate hikes that have been priced in by the markets for 2022 are overly ambitious. Instead, they expect the base rate to be raised by ‘only’ 200 basis points in total over the course of the year. Europe is a different story because here inflation is being driven up primarily by rising commodity prices, i.e. by supply-side factors. Consequently, the ECB’s ability to counteract this trend is limited. Nonetheless, hawkish voices from within the ECB Governing Council have been growing louder and we therefore anticipate two interest-rate increases in 2022.
Yields likely to rise further, equity markets should remain supported
For the capital markets, this means that conditions on the fixed-income side will remain characterised by rising yields for the time being as the central banks tighten their monetary policy. In the baseline scenario, inflation will gradually settle down but will stay above the central banks’ target levels until well into 2023. With regard to growth, Union Investment’s experts retain an optimistic outlook, provided that no full-scale energy embargo is imposed. The corporate profit picture should remain intact and keep share prices supported.
As at 14 April 2022