The longstanding relationship between the U.S. and Europe is changing, with deep consequences for the euro area and its economy. We look into the impact of this metamorphosis on the corporate sector and discuss the related investment opportunities.
May 1, 2025
Frédérique Carrier Managing Director, Head of Investment StrategyRBC Europe Limited
The U.S.’s reciprocal tariffs are on pause until early July 2025, though 10 percent universal tariffs are still in effect, as are 25 percent sectoral tariffs on steel, aluminium, and autos (with carve-outs). The Trump administration is pondering tariffs on pharma, copper and lumber, with the former being the EU’s largest export to the U.S.
For now, unsurprisingly, U.S. trade policies have weighed on European consumer and business confidence. What is surprising to us, however, is that despite the negative impact U.S. tariffs will likely have on the European economy, the euro has appreciated nearly 10 percent 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 percent and 1.2 percent in 2025 and 2026, respectively, compared to 1.0 percent and 1.4 percent back in January.
The downward revisions were relatively small, thanks to the EU’s fiscal stimulus, which we believe will likely cushion the blow. Prompted by signs that the traditional U.S. security support could be withdrawn or at least downsized, the German parliament recently passed landmark fiscal stimulus measures. They include infrastructure investments of as much as €500 billion (or a sizeable 12 percent of annual GDP) over the next 12 years and the relaxation of the limit on structural deficits to allow for higher defence spending, which is a measure that effectively leaves defence spending unconstrained. Meanwhile, the EU has proposed a plan to address deficiencies in the region’s defence capabilities by 2030 with recommended funding of up to €800 billion (for more on this, see our earlier article).
With U.S. trade relations in flux, will the EU seek a rapprochement with its second-largest trading partner? Spain’s Prime Minister Pedro Sanchez recently met with China’s President Xi Jinping to this end. Germany also seems 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 jeopardise 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.
Over the past few years, 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.
Overall, we envision 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., in our view.
For now, Q1 consensus earnings growth expectations for MSCI Eurozone Index companies have retreated since the beginning of the year to -2.0 percent year over year from 7.0 percent. 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 in January and February.
However, we expect the strong euro and tariff uncertainty to compel companies to issue subdued full-year guidance. With 2025 consensus earnings growth expectations at 6.0 percent, there is more downside to earnings expectations if a U.S. policy-induced global growth slowdown materialises and if the euro maintains its strength. Historically, a 10.0 percent appreciation in the euro has shaved some 5.0 percent off earnings per share. We believe 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, in our view, thanks to German fiscal stimulus and the European Central Bank’s (ECB) loose monetary policy kicking in.
Early this year, European valuations expanded from depressed levels as economic activity improved, the ECB loosened monetary policy, and Germany embraced fiscal stimulus. U.S. trade policy uncertainty and the real possibility of high tariffs have set valuations back. 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. So long as a U.S. policy-induced recession is avoided, which is our base case scenario, we see this as an attractive entry point.
We have long favoured companies listed in Europe that are global leaders. Additionally, we recommend seeking to selectively add exposure to companies that can benefit from the ongoing domestic fiscal impulse, including select high-quality banks, as well as companies in the Materials and Industrials sectors, including defence stocks.
With contributions from Thomas McGarrity, CFA
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