UBS Global Research has identified seven key macro themes influencing financial markets this spring, focusing on shifting regional economic performance, central bank decisions, geopolitical risks, and investor behavior. Among these, several emerging trends are worth noting, particularly the relative outperformance of European markets compared to the U.S., shifting dynamics in credit markets, and potential changes in monetary policy from the European Central Bank (ECB).
European Markets Outperforming the U.S.
One of the dominant themes so far this year has been the strong performance of European markets relative to their U.S. counterparts. According to UBS analysts, several factors initially supported this trend, including robust technicals, political stability in France, and positive results from German elections. However, signs of exhaustion are beginning to surface.
UBS suggests that market participants are growing hesitant to push valuations higher, with concerns over future spread widening, particularly in investment-grade (IG) and high-yield (HY) credit. UBS’s credit model suggests a fair value range of 95-100 basis points for IG credit and 300-325 basis points for HY credit. Currently, IG credit is trading at 91 basis points, while HY credit is at 284 basis points, indicating potential risk for spread widening.
The ECB’s Next Moves: Rate Cuts and Economic Projections
The future trajectory of the ECB’s monetary policy remains a crucial uncertainty for the markets. UBS expects a 25 basis point rate cut in March, which is largely priced into the market, with the current expectation sitting at 24.9 basis points. However, UBS anticipates that the ECB could further revise its economic projections, signaling more easing later in the year.
The analysts foresee the ECB lowering its 2025 GDP growth forecast to 0.9%, citing weak economic data from late 2024 and lingering risks, including potential U.S. tariffs on European goods. A shift in the ECB’s rhetoric, particularly a move away from references to “restrictive policy,” could hint at a more aggressive path toward a 2% rate by mid-year, further influencing market sentiment.
Trade Policy and Geopolitical Risks
Trade policy remains a significant wildcard for European markets. UBS analysts are closely monitoring the potential impact of U.S. tariffs on European goods, especially amid ongoing geopolitical developments. While a 10% tariff on European goods is not the base case scenario, it has gained increased attention as a tail risk. UBS estimates that such tariffs could potentially shave 0.2% to 0.75% off EU GDP in 2025.
On a more positive note, UBS suggests that a ceasefire in Ukraine could provide an economic boost to the EU. This could add 0.5% to 1% to EU GDP over the next three years, driven by reduced energy costs, increased defense spending efficiency, and a revival of energy-intensive manufacturing and reconstruction activities.
Germany’s Fiscal Landscape Post-Election
Germany's post-election fiscal environment is another key consideration for UBS. The analysts see three potential scenarios for the country’s fiscal policy moving forward. If the German government successfully establishes the proposed €200 billion special fund for defense spending, it could provide a boost to German credit spreads, particularly in infrastructure-related sectors.
However, if the scope of this fund remains narrowly focused on defense, its impact on the broader market may be limited. Conversely, failure to implement significant fiscal measures could dampen market sentiment, with German spreads potentially underperforming as part of a broader market-wide widening due to the prevailing risk premium.
Conclusion: A Complex Landscape Ahead
In summary, UBS’s spring 2025 outlook paints a picture of a financial market grappling with several interconnected themes. While European markets have outperformed the U.S. thus far, the road ahead is uncertain, with signs of potential exhaustion in equity valuations and credit markets. Central bank actions, particularly from the ECB, and the evolving geopolitical landscape, including potential trade tensions with the U.S. and developments in Ukraine, will play a crucial role in shaping market dynamics over the coming months.
UBS’s analysis underscores the complexity of the current macro environment, suggesting that investors remain cautious but optimistic about the potential for policy shifts and geopolitical developments to influence economic outcomes in Europe.
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