Shaky US economy faces new threats from Europe

Misery loves company. The economy is no exception.

As the U.S. fights stubbornly high inflation and braces for the aftereffects of interest rate hikes, American consumers are also facing headwinds from Europe and the United Kingdom. 

Months of soaring energy prices driven in part by the war in Ukraine have wreaked havoc on the Eurozone, and experts are predicting a grueling, brutal winter across the Atlantic Ocean. 

A looming recession in Europe could sap even more energy from the U.S. economy through a dismal stock market, falling exports, less business from abroad and a decline in tourism. 

“We often say that when the U.S. sneezes the rest of the world catches a cold. Well, the reverse is true as well,” Gregory Daco, chief economist at EY-Parthenon, said in an interview this week.

Steeper stock market swoon

U.S. stocks have plunged this year as higher interest rates, slowing economic growth and stubborn inflation bring the country to the edge of a potential recession. While hiring has remained remarkably strong so far, companies have seen their stock values fall as investors fear the consequences of an economic downturn.

“Such negative views about the economy will impel households to save what they can while the rapidly increasing prices for food and energy eat more into their incomes,” wrote Ross Cioffi of Moody’s Analytics in a Thursday analysis. “With consumers spending less, businesses will also invest and produce less. Uncertainties surrounding supply and demand will cause companies to delay or cancel investments.”

A European recession would first be visible to Americans as another force pushing stocks lower, particularly for U.S. companies that depend heavily on business in Europe.

“The European economy is a large trading partner for the US, so as the European economy gets worse, there would be an additional impact on the US economy,” wrote Angel Talavera, economist at Oxford Economics, in a Thursday email. “There would also be financial spillovers, and given how interconnected financial markets are, a bad recession in Europe would likely cause a lot of volatility in stock markets.”

The ongoing financial market meltdown in the U.K. could also rattle American markets as a former stalwart of the world economy faces soaring prices and a plummeting currency.

U.K. financial markets have been reeling since the newly elected government under Prime Minister Liz Truss proposed a budget that calls for tax cuts for wealthy Britons, energy subsidies and steep cuts to social services. The plan was widely condemned, including by the International Monetary Fund, as dangerous and unrealistic in a time of high inflation.

The value of the British pound has plummeted, and the Bank of England stepped in to stop a collapse of the pension system as bond yields skyrocketed.

“A financial crisis is still a worst case scenario, but you cannot discard anything completely when you have moves of this magnitude,” Talavera wrote. 

More bad news for US exporters and tourism

As Europe’s economy faces slower growth and higher inflation, U.S. businesses involved in making and selling goods to the EU are likely to face a deeper hit.

The strong U.S. dollar has already made American goods more expensive to foreign buyers, and a slowing EU economy will leave those producers with fewer willing international customers.

The weakening EU economy and strong dollar will also take a dent out of international tourism to the U.S., posing more challenges to a sector that typically sees less activity during the winter.

“Europe is facing the brunt of the war on Ukraine on multiple fronts. It’s not just facing the consequences from a geopolitical standpoint, but it’s also facing the direct consequences from supply disruptions, from price increases, and from the disruptions in transportation in a much more direct manner than anywhere else around the world,” Daco said.

Slower US job growth

There are many forces that will likely weaken the job market and boost the unemployment rate as the U.S. heads into 2023, with Fed rate hikes topping the list.

As the Federal Reserve boosts borrowing costs, U.S. businesses will see profits narrow and sales slow down, making it harder to hire — and even retain — some employees. The persistence of high prices and the looming threat of another energy supply shock could also restrain the U.S. job market.

A deep decline in the EU economy could force businesses with deep European operations to pull back their hiring quicker than others and add onto the broader slowdown. 

“What happens in the rest of the world eventually washes up on U.S. shores,” Daco said.

“If the rest of the world is struggling just from an economic perspective, that reduces growth prospects for the US and reduced growth prospects in the U.S. means reduced hiring, reduced business investment, and therefore reduced disposable income,” he said.