Europe’s Slowing Economic Recovery

Economic Outlook Forecasts

• The European recovery is expected to continue but at a softer pace than observed in Q3 2020.
• Euro Area real GDP is projected to contract by 8.5% in 2020 and recover by 6.5% in 2021.
• UK activity is forecast to decline by approximately 11% in 2020, with a 7% recovery expected in 2021.
• Goldman Sachs' 2020-2021 forecasts are slightly more pessimistic than market consensus but align with the International Monetary Fund (IMF) recent release.

Drivers of Economic Heterogeneity

• Recovery trajectories will vary significantly based on the timing and intensity of pandemic waves across different nations.
• Economies with high exposure to trade and tourism are anticipated to suffer deeper initial declines and experience slower recoveries.
• Fiscal policy heterogeneity is a key differentiator; countries with greater fiscal space can provide more robust support to households and firms, accelerating their rebound.
• Goldman Sachs forecasts that the US will return to 2019 real GDP levels by mid-2021, sooner than other major developed economies like the UK or France.
• The crisis is expected to amplify the economic performance gap that emerged between major developed nations and within the euro area following the Global Financial Crisis.

Brexit Negotiation Status and Scenarios

• Goldman Sachs maintains that a trade agreement is still possible and likely to be reached by mid-November, despite the approaching end-of-year deadline.
• Negotiations have stalled primarily in three areas: fishing rights, state aid usage, and the level playing field required by January 1st.
• Current discussions suggest any potential agreement will likely be minimal and subject to revision over time.
• Two primary post-Brexit trade scenarios are identified:
  • Zero-tariff/quota goods exchange accompanied by new non-tariff barriers (base case).
  • Trade governed by WTO rules (non-base case), which carries non-trivial output loss risks for the UK.
• A "no-deal" Brexit scenario would constitute a downside risk to the 2021 economic outlook.

Public Debt and Inflation Dynamics

• The significant increase in public debt in the US and Europe is classified as "good debt" because it was instrumental in preventing deeper consumption slumps and firm failures.
• Record debt levels are not expected to trigger a financial crisis due to very low interest rates that aid debt sustainability and the rollover of maturing securities.
• Goldman Sachs does not anticipate high public debt leading to inflationary spikes similar to the 1970s or 1980s for three specific reasons:
  • Major developed economies face large, negative output gaps that will take time to close, suppressing near-term price pressure.
  • Inflation expectations in both the US and Euro Area remain anchored at or below policy targets.
  • Independent monetary authorities are positioned to tighten policy if inflation deviates upward from mandates, decoupling fiscal stimulus from price setting.

Investment Strategy Recommendations

• Long-term investors are advised to maintain their current strategic asset allocation, keeping equity exposure aligned with their risk tolerance.
• A specific overweight recommendation is issued for the US stock market relative to Europe (IFA) and emerging market (EM) equities.
• The US outperformance thesis is supported by superior demographic trends, innovation capabilities, and economic flexibility.
• The strategy anticipates the continuation of the S&P 500 outperformance versus European and EM equities observed over the past decade post-Global Financial Crisis.