German Stimulus to Keep The Euro Going?

Europe's powerhouse is poised to go on a spending spree that investors hope will reinvigorate the economy, propelling the euro to heights not seen in months.

Historic Spending, Historic Rates

Last week, German debt yields saw their largest move since the '90s as investors interpreted the paradigm shift in government spending as akin to the measures taken during the German reunification. As part of the broader European plan to boost defence expenditure, the leading political parties potentially forming a governing coalition have agreed to reform the "debt brake" restriction. This paved the way for an increased defence budget and an additional €500 billion in investments in infrastructure.

While some of the initial gains have moderated, the German yield curve underwent a dramatic shift. The previously inverted curve, typically signalling investor concerns about an impending recession, has reversed, with the yield on the benchmark 10-year bund surging 30 basis points in a single day. The higher cost of borrowing has propelled the euro to its best three-day rally since 2015, as investors expect that the increased spending will stimulate the European economy and, in turn, provide a much-needed boost to the notorious "sick man." Yields across the continent rose in tandem with the DAX hitting new all-time highs as the European Commission committed to increased spending over the next decade.

The Trade Obstacle

Although specific factors supported the rise in bund yields, they were also part of a global upward trend in interest rates as investors grappled with the potential impact of tariffs. Investors seem to be concerned that the high debt levels in Europe add to the risks of government debt, which has led caution in buying debt. This was exacerbated by the ECB's "hawkish" rate cut past Thursday, which left the door open to a pause at the next meeting and expressed inflation concerns. Markets remain convinced that tariffs are inflationary, and coupled with the uncertainty surrounding their timing, implementation, and extent, investors are asking for premiums when buying government debt around the globe.

The selloff in German debt was the biggest in the past 40 years, as markets scramble to adjust to the new spending expectations, with the German government willing to take on more debt to support its economy. A sudden increase in the cost of long-term debt was the primary catalyst for the considerable market turmoil following the UK's post-minibudget crisis a few years ago. However, Germany's much lower debt-to-GDP ratio is reassuring markets for now. Analysts point to the increased volatility as a sign of the market's ongoing efforts to interpret the implications, particularly as many spending plan details have yet to finalise. Nevertheless, the prospect of more government bonds entering the market, coupled with inflationary pressures, is expected to keep yields elevated and provide support for the euro.

EURUSD Pattern Combo Hints at Upside

The combination of an inverse head-and-shoulders and subsequent leading wedge patterns led to an impulse on the EURUSD to 1.09. This technical setup suggests that the euro could be poised for further gains against the greenback following a correction, capitalising on the nature of the 5-wave substructure. The 138.2% and 161.8% Fibonaci expansions measuring the impulse wave point to 1.1020 and 1.11. Conversely, a pullback below 1.08 may open the door to the 38.2% of the impulse (where 61.8% appears on reverse) near 1.075, with a further drop exposing 1.0630.

Source: SpreadEx / EURUSD

Key Takeaways

Germany's spending plan aims to revive Europe's powerhouse, triggering a surge in German bond yields and fueling investor optimism about the region's prospects. While trade tensions and inflation concerns have supported global yields, Germany's relatively low debt-to-GDP ratio has helped alleviate some fears. As the details of the fiscal plan unfold, however, volatility may persist, with the prospect of increased bond issuance and inflationary pressures potentially continuing to support the euro's upward trajectory.