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As 2024 comes to a close, economic and political volatility seem to be at the forefront in the euro area, but in the US the economic outlook appears optimistic.
On Thursday 5 December, Michel Barnier resigned as French Prime Minister following an overwhelming no-confidence vote against him which was supported by 331 MPs. The vote was submitted on Monday by the far-right National Rally party after Mr Barnier attempted to use Article 49.3 of the French Constitution to force a budget through parliament without a vote. The budget, which fell through, had included tax hikes and spending cuts to the order of 60 billion euros (US$63 billion) in an attempt to get a grip on France’s debt. Mr Barnier warned that voting him out would not solve the country’s financial issues. With bond investors fearful of France abandoning efforts to cut borrowing in the event of a government collapse, French borrowing costs overtook those of Greece for the first time ever on 28 November. On 2 December, the 10Y bond yield difference between France and Germany peaked at 88bp — the highest the gap has been since the 2012 Eurozone crisis.
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A stark difference between the US and the euro area has been in fiscal policy, especially since the pandemic. The post-pandemic rebound has been dominated by almost unprecedented procyclical US deficits, which have contributed to low unemployment and strong growth rates. Meanwhile, the Euro area remains constrained by high debt and the scars from the European debt crisis. Mr Barnier was ultimately brought down by proposing austerity measures without a credible strategy or mandate to boost France’s growth prospects, despite the country running a similar-sized fiscal deficit to the US.
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Want more charts and analysis? Access a pre-built library of charts built by Fathom Consulting via Datastream Chartbook in LSEG Workspace.
In Fathom’s Global Outlook, Winter 2024 we argue that the increasing differences in fiscal policy have already led to growth and interest rate divergence between the US and Europe, and that this is set to continue. The effects of these differing fiscal policies on demand are one key reason why inflation expectations and rates are normalising faster in the euro area.
Fathom also notes the contrast between the US and the euro area over investment, especially the euro area’s increasingly sluggish expenditure on research and development (R&D). The innovation gap between the US and the EU has widened — something that was flagged by former ECB president Mario Draghi in his recent policy recommendations to boost the competitiveness of the euro area. Mr Draghi called for €750-800 billion per year of co-ordinated public and private investments to fund euro-wide investment increases. The report aimed at sparking a debate around what type of government spending should be prioritised to support growth, and ultimately make the fiscal policy constraints in the euro region less binding. Unfortunately, no concrete plans have emerged to move forward on these suggestions. Fathom believes that this inertia will be a significant limiting factor for the euro area’s growth prospects relative to the US.
Greater investment and government spending have translated into stronger GDP growth in America, which has helped to drive US equity markets to significantly outperform European markets. Donald Trump’s re-election and a Republican clean sweep in Congress have been a further recent source of investor optimism that has yet to translate into stronger fundamentals.
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Innovation has played an important role in explaining the stronger US market performance. For example, so far in 2024 US tech stocks have returned almost 40% more than European peers. Much of this US outperformance can be attributed to a group of stocks nicknamed the ‘Magnificent Seven’ — Apple, Nvidia, Alphabet, Microsoft, Amazon, Meta and Tesla — which together represent an ever-rising share of the total market capitalisation of the S&P 500. Fathom research suggests that US corporations, specifically the high-tech sector, not only spend a lot on R&D, but also excel in their ability to translate R&D spending into greater sales.
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This point comes through strongly from a comparison of the earnings of European and US stocks. Since 2022, 12-month forward earnings for US large-cap companies have been on a steady upward trajectory as their European counterparts broadly flatlined. This further divergence in fundamentals is what is supporting loftier US valuations and returns and further highlights the deeply intertwined relationship between economic and financial market trends. We discuss the corporate euro area and more in Fathom’s Global Outlook, Winter 2024. We discuss the corporate eEuro area and more in ourFathom’s Global OutlookGlobal Outlook, Winter 2024. Further analysis and charts from this forecast will be available soon via Chartbook.
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The views expressed in this article are the views of the author, not necessarily those of LSEG.
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