Stocks: Europe better than the United States. How much will Moody’s downgrade on Treasuries weigh on the markets?

Europe will continue to outperform the United States, while the peak of uncertainty linked to tariffs appears to be behind us. Treasuries and markets face Moody’s downgrade.

“We expect Europe to continue to outperform the United States, supported by the large investment plan announced in Germany and by compressed equity valuations, which are particularly attractive in the Italian mid-small cap space, also thanks to the launch of new institutional initiatives. However, for a more sustained rally in global markets, greater clarity on the tariff issue and a return to more accommodative monetary conditions from the Fed will be needed.” That is the view of Andrea Scauri, manager of the Lemanik High Growth equity fund.

Global equity markets ended April essentially flat, in a highly volatile environment. On 2 April, tariffs were introduced at levels harsher than expected: the average tariff rate in the United States rose to 30%, equivalent to an (ex ante) tax increase of nearly $1 trillion, or about 3% of GDP - an unprecedented event in the postwar era. This pushed the probability of a recession in the United States up to 50% from the 10% forecast at the start of the year, with the added risk of stagflation. Later, some signs of trade easing - including the announcement of a 90-day pause on reciprocal tariffs - encouraged an attempt to stabilize markets, which is unfolding alongside earnings season, set to be a crucial test for investor sentiment.

Negotiations have begun, but they will take time. The United States has no hurry to slash tariffs dramatically, and the 10% "base rate" represents a global minimum threshold outside USMCA. Talks could lead to an easing of reciprocal tariffs when they come back into force in July, but in the meantime reactions from various countries have been swift. In particular, China ($450 billion of exports to the US) responded aggressively to tariffs, Japan ($150 billion) and South Korea ($130 billion) quickly moved to start negotiations, while the EU ($606 billion) sought dialogue.

Although the uncertainty shock is significant and will probably filter gradually through to the real economy, there are still few concrete signs at present that tariffs are hitting economic activity hard. The "hard" indicators have remained relatively solid, while the "soft data" (surveys and polls) are showing growing signs of weakening, especially in the labor market. The IMF has revised down its global growth forecasts (to +2.8% from the +3.3% expected in January), stressing that tariffs represent a negative shock to both supply and demand. For the United States, GDP growth has been cut by 90 basis points to +1.8%, with inflation forecasts rising by almost one percentage point to +3%, while for China the 2025 GDP estimate is now seen at 4% (from 4.6%).

In the United States, after a -19% drop from the highs, accompanied by volatility (VIX) levels similar to those seen during the Covid crisis and the 2008 financial crisis, the main indices have recovered about 10% in recent weeks. According to Andrea Scauri, "in times when it is hard to add risk, that is often where risk needs to be added. In Europe, the German fiscal narrative becomes even more important than it was before the sell-off, even from a global equity perspective. This year’s favored stocks, less exposed to tariffs, such as defense names or companies tied to Germany, now offer a much more attractive entry point than in previous weeks. Finally, we underline our lack of exposure to the oil sector. OPEC+’s recent intention to further increase output has put at risk the returns of integrated oil companies and the investment plans of oil services firms".

In the short term, however, Moody’s downgrade of US Treasury securities could weigh on these scenarios. Rating agency Moody's has in fact lowered the rating of the United States from "AAA" to "Aa1" because of concerns about the government’s ability to repay its debt. The timing of the decision, just months after Trump took office as president of the United States, is at the very least suspicious, since Moody's had already warned in 2023 that the triple A rating of the United States was at risk, but had not decided to make the cut. Moody’s now accompanied the decision by noting that “US administrations have failed to reverse the upward trend in deficits and interest costs,” openly referring also to the previous Biden administration, which had been generously “spared” by the agency, having kept a perfect credit rating for the United States since 1917. The downgrade, moreover, came on the same day that Trump’s proposed budget law ran into a roadblock in Congress, with some Republicans voting against it.

Is all this a problem? We will see when markets reopen and throughout the week, for which rating agencies usually have only a limited impact. In fact, while some funds are committed to investment only in triple-A bonds, many others diversify into those just above junk status, and the United States are well above that level. Moreover, US public debt is anything but unreliable, and it remains very high in the special ranking of public debts, with Moody’s classification of “excellent credit quality, with a risk only marginally greater than the Aaa rating.” Furthermore, markets had already largely priced in a deterioration in US debt quality, given that the other two major rating agencies had already begun downgrading the US back in 2013.

Therefore, any speculative reaction is likely to be fairly limited, and it certainly will not be able to push US bond yields up very much, since they are already at rather high levels. The most critical phase regarding tariffs also appears to be over. On the subject, Filippo Garbarino (manager of the Lemanik Global Equity Opportunities fund) says that “generally, tariffs increase inflation and reduce real economic growth; even if the US economy is slowing, we do not expect a technical recession in the short term.” Recent US corporate earnings for the first quarter and estimates for 2025 economic results have been encouraging. The data reported by Visa and Mastercard show remarkable resilience in consumer spending so far this year, and the recent correction in oil prices is positive for retail sales. Moreover, the investment plans expected for 2025 have not been materially revised downward by US companies, a sign of great confidence in the performance of their businesses and the economy.

However, two weak spots remain. The manufacturing sector, with the ISM index still pointing to a phase of contraction. The real estate market, which remains stagnant because of high mortgage rates. “We believe that the S&P 500 low in the 4,800-4,850 area, reached in early April, will not be broken,” Garbarino continues. “We therefore expect that the peak of uncertainty linked to tariffs is already behind us, given that the related news flow should improve in the coming weeks. Trade agreements with some of the main trading partners such as Japan, India and South Korea will soon be signed, significantly reducing the average level of tariffs. Other indicators that lead us to believe the market low may hold are the VIX (volatility index), which touched 60 in April, as well as consumer/investor confidence indices that were signaling strong pessimism and should improve in the coming months, supporting equity markets”.