The U.S.’s reciprocal tariffs are on pause until early July 2025, though 10 % universal tariffs are still in effect, as are 25 % sectoral tariffs on steel, aluminum, and autos.
The Trump administration is pondering tariffs on pharma, copper and lumber. Copper is the EU’s largest export to the U.S. American Trade policies have weighed on European consumer and business confidence.
Despite the negative impact U.S. tariffs will likely have on their economy, the euro has appreciated nearly 10 % against the U.S. dollar. Euro strength generally is a sign of growing optimism around the euro area.
This time, however, international investors, whose trust in U.S. institutions has been shaken, are seeking to diversify some of their dollar holdings.
The extreme uncertainty in trade policies has led the International Monetary Fund to reduce its economic forecasts for major economies. It now expects eurozone GDP to grow 0.8 % and 1.2 % in 2025 and 2026, respectively, compared to 1.0 % and 1.4 % at the start of 2025. The downward revisions were relatively small, thanks to the EU’s fiscal stimulus, which we believe will likely cushion the blow.
The German parliament recently passed landmark fiscal stimulus measures. They include infrastructure investments of as much as €500 billion (12 % of annual GDP) over the next 12 years and the relaxation of the limit on structural deficits to allow for higher defense spending, This move will effectively leave future defense spending uncapped.
Meanwhile, the EU has proposed a plan to address deficiencies in the region’s defense capabilities by 2030 with recommended funding of up to €800 billion.
China
With U.S. trade relations in flux, will the EU seek a rapprochement with its second-largest trading partner?
Spain and Germany seem anxious about fostering good relations with its biggest export partner.
In October 2024, the German government voted against the introduction of EU tariffs on Chinese electric vehicles aimed at offsetting state subsidies provided by Beijing. Though a new government is now in place, the vote highlighted both Germany’s reluctance to jeopardize a key export market and the broader challenge of forging a unified European approach to trade.
Under EU law, while individual member states can engage in specific discussions to address trade issues affecting their national interests, they cannot pursue separate free-trade agreements with non-EU countries. Negotiating trade agreements is the exclusive purview of the European Commission, which does so on behalf of all 27 member states.
Previously, the EU has sought to decouple gradually from China due to growing unease over its dominance as a key supplier, particularly after the war in Ukraine exposed the risks of Germany’s reliance on Russian gas. This push for greater strategic autonomy has been most evident in sectors deemed critical to national security.
A long-term trade resolution with China that reflects a less intense relationship than a few years ago—where trade could remain relatively frozen in some products (e.g., semiconductors, telecommunications equipment) but still flow relatively easily for others (e.g., consumer electronics, textiles and clothing, pharmaceuticals, food and beverages).
Continued trade with China in non-sensitive goods could help cushion the blow of more difficult trade relations with the U.S.
For now, Q1 consensus earnings growth expectations for MSCI Eurozone Index companies have retreated since the beginning of the year to -2.0 % year over year from 7.0 %. This is a relatively low bar to beat given year-over-year base effects are supportive, Q1 regional data were generally upbeat, while the euro remained weak and thus a tailwind.
However, expect strong euro and tariff uncertainty to compel companies to issue subdued full-year guidance.
With 2025 consensus earnings growth expectations at 6.0 %, there is more downside to earnings expectations if a U.S. policy-induced global growth slowdown materializes and if the euro maintains its strength.
Historically, a 10.0 % appreciation in the euro has shaved almost 5.0 % off earnings per share.
Stocks most affected are cyclicals sensitive to global growth. Though dollar weakness is also a negative for European health care companies that derive a large portion of their revenues from the U.S.
For 2026, earnings growth should bounce back by high single digits, thanks to German fiscal stimulus and the European Central Bank’s (ECB) loose monetary policy initiatives.
The MSCI Eurozone Index now trades at 14.9x 2025 consensus earnings estimates, which is in line with its long-term average and close to an all-time low relative to U.S. and global peers on a sector-adjusted basis.
As long as a U.S. policy-induced recession is avoided, (RBC our base case scenario), this can be seen as an attractive entry point.
Focus should remain on companies listed in Europe that are global leaders. Selective exposure to companies that can benefit from the ongoing domestic fiscal direction, (i.e. high-quality banks), as well as companies in the Materials and Industrials sectors, including defense stocks.
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