German bonds slumped and the euro surged as investors braced for a historic increase in borrowing to fund defence and infrastructure investment.
Yields surged the most since mid-2022, the euro rose to a four-month high and stocks rallied after chancellor-in-waiting Friedrich Merz outlined a sweeping fiscal overhaul that could boost the European economy. In the midst of the turmoil, Germany attracted solid demand for a sale of new 30-year bonds.
Merz’s Christian Democratic-led bloc and the rival Social Democrats are speeding ahead with plans to boost investment rather than wait out a months-long process to form a governing coalition. As well as a €500 billion special fund for infrastructure, they proposed defence spending over 1 per cent of GDP would be exempt from the country’s constitutional borrowing limits, known as the debt brake.
“It feels like a game changer,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. He said he has been adding to his fund’s long euro position since Merz’ announcement.
The yield on 10-year notes rose as much as 23 basis points to 2.73 per cent, the biggest jump since June 2022. The euro gained 0.9 per cent to $1.0722, and was on course for its biggest three-day gain since late 2022.
Investors had already started to price in the prospect of Germany dialling back its tight fiscal rules following the election. The 10-year yield has risen over 30 basis points so far in 2025, more than most other bonds in the region. A measure of bunds’ attractiveness relative to swaps has hit successive record lows in data going back to 2007.
Still, German yields remain the lowest among nations in the euro area, reflecting years of fiscal conservationism that have left the country with a limited debt pile. Both investors and officials at the nation’s central bank have urged politicians to spend more in order to give the economy an investment boost.
European governments are under pressure to move swiftly because of US President Donald Trump’s determination to force a quick settlement to the war in Ukraine. On Tuesday, European Commission President Ursula von der Leyen proposed the European Union extend €150 billion in loans to boost defence spending as the bloc and loosen fiscal rules constraining national spending.
“These impressive plans underline that the authorities are thinking big and funding capacities could be maxed to the limit in coming years,” said Christoph Rieger, head of rates and credit research at Commerzbank.
German bonds led yields higher across the region, with 10-year rates from France to Italy and the UK all up more than 10 basis points on the day.
The nation was on course to sell €6 billion in new 30-year bond via banks, in line with analysts expectations. Demand was above €36 billion and the notes were expected to pay 3.25 basis points over a comparable bond, less than the initial price guidance of four basis points, according to a person familiar with the matter.
The side effect of Germany’s new fiscal impulse might be a boost to the bloc’s economy. The country’s unwillingness to spend has been long been pinpointed as a reason for sluggish growth, particularly compared to the US.
European Central Bank officials may address the impact on their growth and inflation outlooks on Thursday. Traders have eased off bets on further monetary easing, pricing less than 75 basis points of further interest-rate cuts this year, compared to about 84 basis points before the investment plan was announced.
The euro’s rapid advance on the back of more discussion about defence spending has fuelled bets in the market that it will gain more than 10 per cent in coming months to $1.20, a level last seen in 2021. Options sentiment, as depicted by so-called risk reversals, turned most bullish the euro in five years, while data from the Depository Trust & Clearing Corp. show that two out of three options this week targeted a stronger euro.
The rally has also seen the likes of Goldman Sachs, as well as MUFG and TD, ditch predictions that the currency will fall to parity with the dollar this year, while firms including Deutsche Bank and Societe Generale are now recommending buying the euro.
“Europe and Germany in particular are showing a historically unprecedented responsiveness to revising the fiscal stance,” said George Saravelos, head of global FX strategy at Deutsche Bank, who is targeting a further rally in the euro to $1.10. “The broadening out of the German fiscal package but more importantly the speed and the ‘whatever it takes’ nature of the policy response have the capacity to create more front-loaded support.” – Bloomberg
