Europe Insights
Key information panel
- The eurozone debt-to-GDP levels are improving, yet further fiscal tightening is needed to return to pre-pandemic levels and meet budget requirements
- Current policy on both sides of the Atlantic resembles the 1990s, still US and European markets trade at a valuation gap. In 1995, US valuations were on par with Europe, but today, the US enjoys an unprecedented premium
- Bond issuance in eurozone is growing strongly, aided by the recent rate cut, historically low spreads and low levels of volatility in both bond and FX markets
Eurozone fiscal stability and future adjustments
Pent-up demand, high inflation and increased nominal growth have boosted income and tax revenues, driving an improvement in debt ratios, with the Eurozone’s debt-to-GDP ratio falling from 99 per cent to 90 per cent in 2023. However, significant fiscal tightening is still required to return to pre-pandemic debt levels. Under the new EU fiscal framework, seven countries will have an Excessive Deficit Procedure (EDP) imposed, implying a sharper fiscal adjustment than their current 2024 budget plans. Looking ahead, despite the potential fiscal challenges, sovereign bond spreads should stay contained, supported by a relatively benign macro-environment, including low gas prices, ongoing disinflation, rising real income and further ECB rate cuts.
European equities: lessons from the past
The current soft-landing scenario resembles the mid-1990s. Both Fed and European policy conditions back then mirrored today’s environment. The significant difference now is the valuation gap between US and European markets. In 1995, US valuations were on a par with Europe, but today the US enjoys an unprecedented premium. US valuations are at levels comparable with late 1997 to early 1998 (just before the internet crash), while Europe trades like it’s still 1995.
European bonds are back (part 2)
Investment-grade euro bond issuance (corporates and financials) has increased by over 16 per cent compared with a year ago, and high-yield issuance so far this year has already surpassed the entire volume of 2023. Current spread levels reflect the market’s confidence in corporate fundamentals, and despite a slight widening in June, spreads remain on their compression trend. The low level of volatility observed on both bond and FX markets may also explain why 17 per cent of investment-grade euro-denominated emissions have been initiated by US companies.