Macro-financial disconnect in the euro area: Assessing tail risks to euro area growth and equities

The euro area is experiencing a combination of low growth and persistently high policy uncertainty, but financial conditions are remarkably supportive and valuations now look stretched following the brief correction triggered by the 2nd April US tariff announcement. Using a growth-at-risk framework, survey forecasts, and option prices, this column shows that downside risks to euro area growth are at comparable levels to those during past crisis episodes and that financial markets appear to be under-pricing these risks. This ‘macro-financial disconnect’ between equity markets and real sector forecasts leaves the economy vulnerable to a sharp repricing if risk appetite turns.

The European Commission’s Autumn 2025 forecast points to a subdued but positive growth outlook for all euro area member states over 2025 to 2027, supported by easing inflation and robust labour markets. At the same time, measures of economic and trade policy uncertainty have reached historic highs in recent months, while volatility in global financial markets continues to be unusually low. Policymakers, including those at the European Systemic Risk Board (ESRB), warn that markets may be under-pricing risks related to trade restrictions, geopolitics and US fiscal policy.

A useful way to cut through this tension is to focus on tail risks, not just the baseline forecast. The ‘growth-at-risk’ (GaR) approach, now widely used in policy work, summarises how weak growth could plausibly be over the coming year given today’s financial and macro conditions (Adrian et al. 2019, Cecchetti and Schoenholtz 2018). In this column, we draw on our ESRB note that combines this framework with density forecasts from the ECB’s Survey of Professional Forecasters (SPF), analysts’ earnings forecasts, and option-implied return distributions for the EURO STOXX 50 (Andersen et al. 2025). Together, these tools allow us to compare the left tail of expected GDP growth with the price investors are willing to pay to insure against large equity losses, a check on whether calm markets are consistent with the prevailing level of downside risks to economic growth.

Looking at the whole distribution, not just the baseline

We start by examining the evolution of real GDP growth expectations using the ESRB’s GaR model and the ECB’s Survey of Professional Forecasters (SPF).

For the GaR model, we estimate the impact of financial conditions, economic policy uncertainty, and a range of other macroeconomic and financial indicators on the full probability distribution of one-year-ahead real GDP growth in the euro area. To capture downside risk, we focus on the 10th percentile (left tail) of the distribution at various dates over the past year.

Our estimates reveal a pronounced thickening of the left tail of euro area growth over the course of 2025 (Figure 1a). In Q3 2024, prior to the US election and the subsequent tariff announcements, the model placed the 10th percentile of one-year-ahead growth at around -0.6%, which is above the historical 10th percentile of about -1.1%. By mid-2025, the 10th percentile had fallen into a range between roughly -1.7% and -2.6%, implying a materially higher probability of outright contraction.

Survey data tell a similar but more muted story (Figure 1b). The SPF’s distribution for euro area GDP growth over a one-year horizon also shows some thickening of the left tail, with the 10th percentile falling from around zero in 2024 to approximately -0.4% in 2025. The tighter probability distribution observed with survey data aligns with evidence that the SPF tends to underestimate the tails of the distribution and the likelihood of extreme outcomes (Clements 2011, Rich et al. 2012, Allayioti et al. 2024).

Figure 1 Significant tail risks to euro area economic growth prospects

x-axis: one-year-ahead GDP growth

Sources: ECB (SPF, Statistical Data Warehouse), Eurostat, policyuncertainty.com and ESRB calculations.
Note: The red and green arrows in the grey boxes indicate whether the 10th percentile GDP growth rate has decreased (red) or increased (green), for each specific forecast method.

Policy uncertainty, not markets, is driving tail risks

To complement these results for the current year, we examine longer-run estimates of GaR. Figure 2 shows the history of the 10th percentile of one-year-ahead euro area growth together with a decomposition into key contributors. Three key features can be inferred from the chart.

First, the longer-run estimates show that tail risks to growth at present are high and within the range seen at the height of the global financial crisis, the euro area sovereign debt crisis, the COVID-19 shock, and the high inflation episode of 2022 to 2023.

Second, the dominant force pushing GaR down over the past year has been economic policy uncertainty. We proxy this using the Baker et al. (2016) indices, which measure the intensity with which newspapers discuss economic uncertainty and specific policy keywords. Since early 2025, these indices have hovered near historical highs, reflecting tariff tensions, geopolitical risks, and concerns over US fiscal sustainability.

Third, financial conditions, represented by Duprey et al.’s (2017) Country-Level Index of Financial Stress (CLIFS), which incorporates equity prices, have a positive impact on our GaR estimates in 2025, cushioning downside risks to growth. This differs from previous episodes of stress when CLIFS was a major negative contributor to GaR. In the past we have generally seen economic sentiment move in tandem with financial stress. However, since 2023 the contributions of these indicators have moved in opposite directions and economic sentiment has been contributing negatively, reinforcing the contribution of policy uncertainty.

Figure 2 Decomposition of the GaR model at the 10th percentile

One-year-ahead real GDP growth, annual growth rates

Sources: ESRB Secretariat, also in conjunction with the ECB/ESRB workstream on financial stability risks from geoeconomic fragmentation.
Notes: The plot shows the quarterly GaR, broken down into the contributions of the explanatory variables included. It is measured by the 10th percentile as estimated under the ESRB GaR specification.

Are investors under-pricing macro risk?

If policy uncertainty is weighing so heavily on GaR, why are euro area equity markets still so buoyant? By late November 2025, both the EURO STOXX 50 and the S&P 500 were up around 15% year to date. The April ‘tariff turmoil’, when sweeping US tariff announcements triggered sharp declines in global equity prices, proved short-lived, with stock indices quickly rebounding to new highs.

Earnings expectations also suggest that this optimism is not fully grounded in fundamentals. In the wake of the April tariff shock, analysts revised down their 2025 and 2026 earnings forecasts for EURO STOXX 50 firms and they continued to drift lower to around 6 to 8% of their pre-April levels (Figure 3a).

Option prices offer a more direct window into market perceptions of tail risks. Using standard techniques to recover risk-neutral return distributions from EURO STOXX 50 options, we compare the one-year-ahead distribution of equity returns as of September 2024, early April 2025 and early November 2025 (Figure 3b). After the April shock, the left tail of the distribution thickened noticeably, consistent with a higher perceived probability of large equity losses. By November, however, the options-implied distribution had reverted to something close to its pre-election shape and in fact displayed less downside mass than the long-run historical distribution.

Figure 3 Strong recovery for equities after the April turmoil and reduced uncertainty

Panel a) y-axis: index, 100 = 1 January 2025; panel b) x-axis: one-year-ahead index percentage return

Sources: Bloomberg Finance L.P., ESRB calculations.
Notes: In panel a, the shaded areas represent the earnings seasons. The historical distribution in panel b is based on data from 1987-2025.

In other words, while severely adverse macroeconomic risks, as captured by GaR, remain elevated, investors’ view of downside risks to equity prices remains benign. Combined with the downward drift in earnings expectations, this gap suggests a macro-financial disconnect where markets appear to be discounting the growth implications of persistent policy uncertainty.

This conclusion is consistent with broader evidence that markets often respond sluggishly to policy-related news, with trade policy uncertainty generating bouts of volatility and time-varying risk premia but only gradually feeding into prices as its effects on growth become clearer (Adolfsen and Harr 2025, Grothe et al. 2025).

What if financial stress returns?

A natural question for macroprudential authorities is what would happen if financial conditions were to turn from cushioning downside risks to amplifying them. To address this question, using our GaR model we estimate a shift in CLIFS during the latter half of 2025 corresponding to the levels of financial stress observed during the COVID-19 turmoil and the global financial crisis.

If financial stress in the euro area were to return to such crisis levels, the model implies that one-year-ahead GDP-at-risk (the 10th percentile) drops by between 2.7 and 3.3 percentage points relative to current levels. While this is a partial-equilibrium exercise, it highlights the sizeable adverse impact that renewed financial stress could have in an already fragile growth environment.

Conclusion and policy priorities

Risk assessment should focus on the distribution of adverse possible outcomes, rather than focusing solely on the baseline scenario. Growth-at-risk frameworks, survey-based distributions and option-implied densities are complementary tools that can reveal divergences between macroeconomic risks and market pricing – insights that are often obscured in point forecasts. The ESRB’s experience suggests that these tools are valuable when uncertainty appears high, but market-based measures of volatility are low.

For an open economy exposed to trade and geopolitical shocks, calm markets are not a reliable signal that uncertainty has become harmless (Handley and Limão 2013, Bloom et al. 2019). Policymakers should never assume that low volatility will persist. It is essential that they take advantage of benign financial conditions to build and maintain capital and liquidity (Nier et al. 2020, ESRB 2021). Furthermore, market participants need to ensure that they have sufficient buffers to withstand a sudden rise in market volatility and possible adverse repercussions, such as falling financial asset prices and higher credit spreads (Andersson et al. 2017). 

Source : VOXeu