Market Views: Positioning European assets in portfolios after ECB rate cut
The European Central Bank's (ECB) decision to cut interest rates for the first time since 2019 marked a divergence in monetary policy between the US and European economies.
On June 9, the ECB lowered its main deposit rate by 25 basis points from 4% to 3.75%. The move follows rate cuts from other central banks in Europe such as Sweden and Switzerland.
ECB President Christine Lagarde stated that key reasons to start lowering the policy rate included the outlook for lower inflation, the weakening dynamics in underlying inflation, and the strength of monetary policy transmission.
The US Federal Reserve, meanwhile, held interest rates steady between 5.25% and 5.5% to curb inflation. The Fed also revised the rate cut outlook to just once in 2024 compared to its previous forecast in March of three cuts, leaving a widening rate differential between Europe and the US.
Historically, the eurozone has only cut rates before the US during the euro crisis.
The ECB is currently less concerned about the economy overheating, making them more comfortable about easing monetary policy ahead of the Fed. However, upcoming political elections in Europe are also expected to influence the market.
We asked fund managers how all this could impact investor portfolios across different asset classes, including equities, bonds, and currencies.
The following responses have been edited for brevity and clarity.
Ben Ritchie, head of developed markets equities
abrdn
Over the past 40 years, European equites have gone on to perform very well in the 12 months following the first interest rate cut.
As a result, we believe the outlook is particularly promising, especially for our strategy that prioritises a highly selective and quality-first approach.
Globally Europe stands out due to its appealing valuations, especially when compared to the United States, coupled with a relatively low level of investment from global investors.
These provide significant dry powder that could be deployed into the market.
This, along with improving economic growth at the same time as the US economy begins to slow, creates a stable environment that is beneficial for high-quality companies.
While the recent European elections have caused some concerns around political risk, especially in France, in our experience domestic developments make limited impacts on the global leaders that make up much of our portfolio such as Novo Nordisk or ASML.
Indeed, Europe’s international exposure, with around 50% of the revenues of European companies coming from outside the region, also positions it well to be able to take advantage of developments around the world and access fast-growing emerging markets.
We are also seeing greater dispersion in performance within sectors and geographies which means it is becoming increasingly important to adopt a selective approach at the company level, with a strong emphasis on the ability to deliver long-term earnings, which should favour stock pickers.
Overall, we are very positive about the prospects for European equities as a combination of low valuations, declining discount rates, weight of investor flows and strong company-level opportunities provide an attractive cocktail for investors.
Marc Franklin, senior portfolio manager, asset allocation, Asia
Manulife Investment Management
The ECB’s inflation and growth forecasts were actually revised higher for 2024 and 2025 and President Lagarde refused to commit to any future path of further rate cuts.
Whilst the ECB may have the scope to make more rate cuts than the US in 2024 owing to more pronounced disinflation dynamics, its default to a data-dependent approach is aligned with the US Federal Reserve’s current approach.
This therefore suggests that the ECB does not have the conviction to pursue a materially divergent monetary policy path from the US.
We therefore don’t expect the ECB’s monetary policy approach this year to materially impact prospects for European equities, certainly on a relative basis compared to other equity markets.
Neither do we think the ECB’s monetary policy decision-making will influence the Fed’s monetary policy decision-making owing to the latter being principally focused on setting policy based on domestic US economic considerations.
What could be more meaningful for European equities are the snap elections called for France and Belgium owing to the surprise results in the European elections over the weekend. Any loss of power by mainstream parties could trigger risk aversion towards European equities.
Luca Paolini, chief strategist
Pictet Asset Management
We expect the ECB to cut twice as much as the Federal Reserve in this easing cycle.
We think that eurozone quarterly GDP growth can reach potential by the end of 2024, exceeding 1% annualised.
Among regions, we see some of the best potential in developed markets beyond the US – namely in the eurozone, Switzerland and Japan.
All three offer much more attractive valuations than the US, which is by far the most expensive region in our model.
Prospects for the eurozone are supported by a positive reading on our leading indicators, while Switzerland offers positive corporate earnings dynamics and quality stocks at a more than reasonable price.
Our analysis shows that eurozone stocks are becoming more attractive. There are strong reasons to believe corporate earnings could turn out to be stronger than market expectations thanks to a favourable macroeconomic and monetary policy backdrop.
It shows an acceleration in economic activity – as measured by the purchasing manager surveys – is typically accompanied by analyst upgrades to 12-month earnings estimates.
According to our calculations, eurozone companies should see earnings per share increase by just over 4% this year, higher than the consensus forecast of 3.1%.
With this in mind, we upgraded European stocks to overweight from neutral in May and maintain this stance.
Marcella Chow, global market strategist
JP Morgan Asset Management
Even though ECB President Christine Lagarde would not commit to future rate cuts at this point, she did highlight that there was a strong likelihood that the ECB was entering a dialling down phase.
Markets are pricing between one to two additional 25 basis points rate cuts by year end, and a terminal rate of around 2.5% by mid-2026.
European economies are more sensitive to rates than the US, especially due to the much shorter maturity of European corporate debt compared to the US, prompting the ECB to cut rates first rather than risk acting too late.
The benefit from lower rates is also comparably higher given eurozone’s higher dependence on bank lending, while the US is more credit market dependent instead.
We continue to see ECB’s path to lower rates to be much clearer and rate cuts should have a more immediate supportive effect in the eurozone. This also provides a fairly attractive backdrop for European sovereigns, particularly more rate and growth-sensitive peripheral members.
For equities, earnings growth expectations have increased, and earnings revision ratios have started to trend higher.
Most sectors are trading at meaningful discounts to their US peers, particularly within food retail, energy, tech hardware and banks.
Meanwhile, we believe that luxury goods, coupled with healthcare, fiscally supported climate tech and semiconductor firms continue to offer attractive diversification opportunities for investors exploring the European markets.
Michael Browne, chief investment officer
Martin Currie
The question remains what the ECB will do about the next cut? July is now being taken off the table by the market, but September remains very much on the cards.
Any hint of another cut in July would reverse the bond market.
Bond markets have reacted negatively to expected rate cut and headlines of a slower and steady approach to further cuts.
It’s a statement of the nervousness of bond traders at the moment to make sure they are not caught out by a directional movement or commentary.
Until the trend to cuts becomes well established, we will continue to see volatility in bonds and that is also reflected across equity markets.
Monetary remains restrictive, growth remains weak across Europe and very weak in the core, especially Germany.
This is the first of many cuts, the only question is over what period of time, some will want to move faster, some slower but the destination is clear. This is the first time the ECB has entered the rate cutting phase before the Fed.
We will see a great focus on wages going forward with wage settlements having peaked. It became clear that the ECB is bullish on wages in the medium term.
Roberto Coronado, senior portfolio manager
PineBridge Investments
Following its first rate cut at its June meeting, market expectations for the ECB are coalescing around three rate reductions this year, each by 25 basis points. Our base case is aligned with market sentiment; primarily that the ECB has scope to continue cutting rates independently of the Fed.
As has been stated by the ECB, they, along with the Bank of England, will continue to be informed not by Fed policy, but by the economic data published over the next 6-12 months.
We believe that if growth and inflation figures continue to point towards monetary easing, both central banks will continue to do so.
We foresee consequences for fixed-income markets. Lower rates in Europe and the UK compared to the US would likely widen the interest rate differential.
Practically, this will likely involve overweighting European bonds relative to US Treasuries, as we expect bunds and gilts to outperform given the possibility of the ECB and BOE to cut rates more aggressively than the Fed.
Additionally, we maintain a cautious outlook on currencies, favouring the US dollar due to expected rate differentials, while remaining alert for more attractive entry points as market conditions evolve.
Given the current economic uncertainties and potential tail risks, we recommend maintaining a more defensive stance in fixed-income allocations
. A "barbell" approach, combining defensive, lower-risk positions with higher-yielding, higher-risk credit assets, appears prudent.
Geoff Yu, senior EMEA market strategist
BNY
Wage growth in the services sector remains resilient despite ongoing weakness in manufacturing, and the ECB’s narrow mandate to focus on bringing inflation to target will limit their ability to react to other factors.
However, the ECB’s reluctance to commit to further moves should not be taken as a change in direction either.
The unexpected introduction of political concerns in France and through the European Union has only increased pressure on the currency.
Meanwhile, if developments in eurozone sovereign bond markets become disruptive, the ECB will also react forcefully through easing.
The Fed will be monitoring its counterpart’s trajectory as dollar strength is potentially becoming very problematic.
The euro is a key component of a trade-weighted dollar and with the Fed likely to only begin easing in September, when the ECB could cut again, the risk is for the dollar to continue to strengthen.
Meanwhile, there is no ‘help’ from other currencies: The Bank of Canada cut rates a day before the ECB, the Mexican peso is under pressure after the Mexican elections, while rates in China and Japan will remain too low to sustain recovery in their own currencies in the near term.
These currencies account for almost 80% of the dollar’s trade-weighted index, and the Fed will need to be extremely attuned to risks of a strong dollar introducing disinflation to the US beyond their expectations, generated by lower import prices and reduced export earnings.