World financial markets remained in a radical readjustment phase on Thursday as the implications of Germany’s fiscal shift continued to reverberate across global debt markets.
The sell-off in German bonds, triggered by Berlin’s plan to unlock hundreds of billions of euros for defense and infrastructure investments, has dragged down sovereign debt markets worldwide. Investors scrambled to adjust their portfolios after this seismic shift, marking a stark departure from Germany’s traditionally cautious fiscal stance.
The yield on the benchmark 10-year Bund climbed another 11 basis points to 2.90 percent by late afternoon, following its steepest single-day rise in nearly 30 years on Wednesday. At one point, Bund yields reached 2.929 percent, their highest level in 14 years, further amplifying concerns about global borrowing costs. The repercussions rippled across Europe, with French and Italian debt yields also pushing higher.
This dramatic move followed a historic announcement from opposition leader Friedrich Merz, who promised on Tuesday he would do “whatever it takes” to defend Germany—a pointed echo of former ECB President Mario Draghi’s decisive pledge during the Eurozone crisis.
31-basis-point surge in 10-year yield
Merz’s proposal includes exempting defense spending above 1 percent of GDP from Germany’s constitutional borrowing limit, the ‘Schuldenbremse’, establishing a 500 billion euro off-balance-sheet vehicle for infrastructure investment, and loosening debt restrictions for German states. The result: a 31-basis-point surge in the 10-year Bund yield—the largest in the German debt market since 1997.
For many investors born after 2000, a one-day move of more than 25 basis points in the 10-year Bund yield is unprecedented, highlighting the magnitude of the market’s repricing.
Jim Reid, Deutsche Bank’s head of global macro and thematic research, said in a Wednesday note to investors that Germany’s new fiscal plans represented “one of the largest fiscal regime shifts in post-war history, perhaps with reunification 35 years ago being the only rival.”
“Everything you thought you knew about Germany’s economic prospects three months ago, or even three weeks ago, should be ripped up and you should start your analysis from fresh. This is game-changing if it goes through.”
Jim Reid, Deutsche Bank
“Everything you thought you knew about Germany’s economic prospects three months ago, or even three weeks ago, should be ripped up and you should start your analysis from fresh. This is game-changing if it goes through,” Reid wrote.
The deal’s open-ended borrowing for defence and the proposed 500 billion euro spending vehicle for infrastructure underscore Germany’s break with fiscal conservatism.
France, Italy face heightened pressure
Moritz Kraemer, chief economist at LBBW, pointed to potential broader implications for the Eurozone. “Spare a few thoughts on the weaker-rated sovereigns, like Italy and France, whose public finances had been unsustainable even before the jolt in long-term rates. Without any doubt, they face heightened pressure now,” Kraemer noted on LinkedIn.
Germany’s status as the Eurozone’s benchmark safe asset means its yield moves influence borrowing costs across the region. France’s 10-year OAT yield climbed 7 basis points to 3.56 percent. The 10-year spread between German and Italian government debt narrowed to 105 points, its smallest since October 2021.
European Central Bank President Christine Lagarde noted the significance of Germany’s fiscal shift during a press conference Thursday, saying, “Intuitively, if all that works… it will boost growth, but more to come. We need to be attentive during the coming days, weeks, and try to anticipate economic consequences it will have. It is work in progress—if the proposed European Commission massive borrowing programme is adopted, with the Merz plan, it would have fiscal impact and impact on demand.”
Potential ECB rate pause in April, if backed by data
Lagarde also addressed monetary policy amidst the evolving economic landscape: “The situation we face at this moment is predicated by the disinflationary track. Monetary policy is meaningfully less restrictive. The landscape we have at the moment is clouded with uncertainty. More than ever before it requires that we are vigilant—we will all have to be extremely vigilant. We will have to be agile to respond to the data. If data indicated the most appropriate policy stance is a cut, it will be a cut. If, on the other hand, data indicates a pause, it will be a pause. Our mandate is price stability. We will adhere strictly to our mandate.”
Further reading on Investment Officer Luxembourg:
- Germany votes: a return to the 1930s or stability of the 1990s?
- Europe’s forgotten market: can unloved investments stage a comeback?
- German elections: potential boost for the EU bond market