Take as your basic ingredients the recent end of the European Central Bank's fiscal stimulus, aka quantitative easing (QE), ongoing historically low interest rates in the eurozone, which limit room for an effective monetary policy, and political antipathy toward using fiscal policy (i.e. taxes and spending) as a way of countering cyclical economic downturns.

Sprinkle on some of the effects of the US-China trade row, the economic impact of Brexit and a splash of Italian crisis. Mix thoroughly and flavor with a likely recession in Germany before topping off with the looming existential question of how the EU responds to these various crises and what kind of EU will emerge. Bake at high temperatures while avoiding the rise of far-right parties across Europe but serve on a bed of social discontent.

Wall Street smells a rat

Markets, like us all, are struggling to digest this delightful dish. The US yield curve, keenly watched as a gauge of Wall Street sentiment, inverted last week for the first time since 2007. When short-term Treasury bonds pay a higher interest rate than long-term bonds, one can be sure that investors believe an economic crash is on the cards and that central banks will have to cut rates and keep them low for a long time. Many see a contraction in the US economy as early as next year.

"Recession warning bells rang out across the markets as Trump's delaying of tariffs on some Chinese imports is a case of too little too late, the damage to economies has already been done," Fiona Cincotta, senior analyst at the spread betting firm City Index, told The Guardian newspaper.

Germany first

Germany noted the first signs of recession, as did the UK, while the eurozone barely scraped into positive growth territory in the second quarter of 2019. The German economy, the world's fourth-largest, contracted by 0.1%, halving the rate of the 19-member eurozone from 0.4% in the previous quarter to 0.2%. Germany is unlikely to fare much better in the third quarter and two quarters of contraction officially mean recession. 

Exports make up almost half of the German economy with its companies playing a major role in global markets for luxury autos and complex industrial machinery. German profits are often invested in factories in Slovakia, Hungary and Poland. According to the Center for European Reform, the Visegrad 4 (Poland, the Czech Republic, Hungary and Slovakia) collectively is now Germany's most important trade partner, ahead of China and the US, due to their integration in EU supply chains.

Slower but still strong in CEE

The European Central Bank will not be hiking eurozone rates soon, but this could be good news for investors in central and eastern Europe (CEE), where growth has been stronger than the rest of the continent.

But slowing growth in western Europe has already fed into slower growth in CEE. The last quarter was the first since 2016 that growth slowed in all six countries of CEE: Bulgaria, the Czech Republic, Hungary, Poland, Romania and Slovakia. Hungary, Romania and Poland still lead EU growth rates, but all their annual growth rates were down from 4.3% year on year in the first quarter to 4% year on year in the second. This against "old Europe's" growth rate of 1.1%.

The slowdown was larger than analysts had expected in Poland and Slovakia, while growth held up better in the Czech Republic, Hungary and Romania. CEE economies are heavily dependent on German growth as, roughly speaking, 20-30% of total exports are being shipped to Germany, says Zoltan Arokszallasi, an analyst at Erste Bank Hungary.

"However, recently the region was somewhat resilient to the German slowdown. This is mostly due to domestic demand that is helping these economies to grow. This means that household consumption (because of increasing wages and employment) and investments (strongly helped by EU fund inflows) are having a positive effect."

Industrial data over the next few months will be difficult to read, given that summer could make the figures cloudier, but it is unlikely to see strong numbers in the months to come, Arokszallasi says.

"Looking forward for the upcoming quarters, we think that a slowdown will come in GDP growth for the CEE region," Arokszallasi adds, noting that domestic consumption and investments will help, as the scarcity of labor is continuing to push wages up, while EU-funded investments are also ongoing. 

The upsides for CEE

Several factors are involved in the relative upside story in CEE. One is the labor shortage across the region that has fueled wage growth, on the back of which households are taking on new mortgages and buying more cars. The tight labor market is one common feature across the region, according to BNP Paribas Real Estate. 

Secondly, currencies and bonds across eastern Europe have largely discounted the GDP data as changes in global investor sentiment remain the key driver for trading. Apart from Slovakia, which joined the single currency in 2014, CEE economies are equipped to deal with lower exports via exchange rate policy.

Thirdly, Poland and Hungary are spenders. Both governments appear to relish the power of spending and for the time being can afford to do so.

Slovakia in the firing line

Slovakia has seen strong growth since it joined the EU in 2004, its economy closely linked — mainly via exports of manufacturing goods — with the German economy, where 23% of its exports end up. But its economy, dominated by car manufacturing, slowed unexpectedly in the quarter.

"Slovakia is feeling the impact of the global slowdown and the economic stagnation in Germany, our biggest trade partner," VUB Bank analyst Michal Lehuta told Reuters.

The auto industry accounts for 44% of industrial output and 40% of exports. At the end of 2017, VW Slovakia employed 13,700 people making Touareg SUVs, Audi Q7s and Porsche Cayennes for the US market. Car manufacturing at factories run by Volkswagen, Peugeot, Kia and Jaguar Land Rover fell for the first time in 18 months in June, dropping by 7.6%.

A partial shutdown at oil refiner Slovnaft and output cuts at United States Steel Corp's Slovak factory pushed growth lower. 

Poland and Hungary spending

Poland ceased to be designated as an emerging market for stock investors in 2018 and one of the most important features of the economy is its large domestic consumer market, making up 61% of GDP, exceeding the EU average. That means less dependence on the German economy, although its neighbor is still Poland's largest trading partner.

The Law and Justice (PiS) ruling party is intent on spending its way out of any downturn in the economy, in particular as a general election looms in October.

With 3.7% growth in 2019, Hungary ranks as the fifth-fastest-growing economy in the EU, according to the European Commission forecasts, but the brewing global trade war is a particular concern for Hungary, given its reliance on foreign trade. A new spending spree from Prime Minister Viktor Orban is expected.