Davos reaches 'peak pessimism' for Europe as US enthusiasm grows

Christine Lagarde warns of 'existential crisis' for continent as Donald Trump puts America first

Investors have warned of Europe's vulnerability to Donald Trump's "America First" policies.

Trump's plans for tax cuts and reforms sparked a burst of enthusiasm from many US leaders at the World Economic Forum in Davos this week, while on Wall Street the S&P 500 came very close to a new record at the close on Wednesday.

But the mood about Europe was much darker. One head of a major US bank warned of “maximum pessimism” for the continent. The threat of US tariffs on Europe added to the worries of leaders and politicians in Davos, who warned that a rising US economic wave could weaken confidence on the other side of the Atlantic.

Christine Lagarde, president of the European Central Bank, said it was not "pessimistic" to say that Europe is facing an "existential crisis".

Trump has inherited a rising
S&P 500 stock market (points)

Europeans had to be realistic, Lagarde said on a panel discussion. “We are now getting this big push because another major player in the global economy is organizing things in a different way and is threatening some of the partners and players that that country was cooperating with before.”

Forecasts from the IMF this month significantly improved the economic outlook for the US this year, predicting growth of 2.7%, well above the Eurozone's projected expansion of 1%.

The eurozone's largest economy, Germany, has seen two years of contraction and is forecast to expand by just 0.3% this year. Meanwhile, the US received a record share of cross-border greenfield investment projects in the 12 months to November, according to preliminary data from FDI Markets.

The main risk in the US is that Trump's agenda ends up fuelling inflation and preventing the Federal Reserve from cutting interest rates. The IMF warned of the risk of rising prices if Trump overstimulates the US economy while curbing the supply side of the economy by cracking down on immigration.

While stronger US demand will benefit countries that rely heavily on US exports, investors in Davos spoke of the risk that growth in Europe could undercut already gloomy forecasts.

Strained public finances in countries like France and the UK could leave them exposed to a further rise in long-term borrowing costs, driven by tax cuts in the US.

Rising US Treasury yields are raising European countries' borrowing costs

Ursula von der Leyen, president of the European Commission, said the EU and the US must negotiate to preserve trade relations, given that with trade volumes between them at 1.5 trillion euros and massive transatlantic investment, "much is at stake for both sides."

Brussels hopes that threats of high tariffs will be a precursor to deals that avoid some of those barriers, as they did in Trump's first term. But the gap with Brussels was on full display this week, after Trump announced the US withdrawal from the Paris climate agreement, a cornerstone of EU policy and the World Health Organization.

The European economy had shown “resilience” in the face of shocks such as Covid-19 and the rise in energy prices following Russia’s invasion of Ukraine, said Valdis Dombrovskis, the EU’s economy commissioner. But he acknowledged that deeper fragmentation in the global economic system would be “very costly for the EU, given that the EU is a trading superpower.”

At the same time, an attempt to change regulations in the US could further harm European competitiveness if governments fail to mount an effective response.

Regulation of technology and artificial intelligence will prove to be a key test./ Monitor