ANALYSIS: German debt brake reform & spending measures weigh on Bunds and lift the EUR

• In brief, CDU's Merz (the likely next Chancellor), the CSU and SPD leaders announced an agreement on the first phase of reform. Reform which they hope to pass in the next week and as such get through under the current Bundestag configuration where a two-thirds majority for constitutional reform can be attained.


• The drive to pass the measure in this parliament is due to Die Linke and AfD holding a one-third blocking minority in the incoming Bundestag; as such, we are very attentive to any calls from them for an early recall of the Bundestag.


• The measures announced by Merz and others include a special EUR 500bln 10yr fund for infrastructure investments, changes to the debt brake to exempt defence spending of more than 1% of GDP from such rules, a loosening of the regional balanced budget requirement and a new instrument to provide EUR 150bln of loans.


• Within this, the defence adjustments would be a likely red line for Die Linke and debt brake reform in general is an AfD red line, hence the drive by Merz to push the measures through in the current Bundestag configuration.

Reaction

• In the wake of this, Bunds are under marked pressure with downside of over 250 ticks at most with the low for the session at 129.66 vs Tuesday's 132.24 close. Yields are bid across the curve with the front end firmer by around 10bps and the long end by over 20bps. Steepening action which is likely occurring given the longer-term fiscal implications of such reform and as the front-end awaits the ECB on Thursday and Trump's tariff decision on the EZ.


• Spreads are narrowing on the back of the gains in German yields (note, the yields of European peers are also elevated, but to a much lesser extent). Action which has driven the BTP-Bund 10yr spread below the 100bps mark and seen the OAT-Bund spread test 65bps to the downside.


• Deutsche Bank wrote that they see the potential for EUR/USD to get back to 1.10, driven by the additional spending and investment that the above reform would unlock. As it stands, EUR/USD is at a 1.0670 high for the session which is a YTD high and the strongest the EUR has been against the USD since November 11th 2024. Elsewhere, EUR/GBP is bid but well within recent ranges.


• Futures across Europe are in the green with the DAX 40 outpacing and numerous German names seen posting gains in a range of +1% to +10% depending on their exposure to the above and other equity specifics, i.e. earnings from Bayer and Adidas, factoring and in some cases offsetting this.

Next Steps

• We remain attentive to any signs that the new Bundestag could sit earlier than the scheduled 24th March date.


• Any indications that there will be political and/or legal challenges to the reform under the new parliament or lodged with the Constitutional Court; such challenges could, theoretically, lead to any reform being overturned at a later date.


• What, if any, concessions Merz or similar have had to give to parliamentary groups in order to secure a two-thirds majority in the current Bundestag.


• Any delays to the current plan of passing the reform in the Bundestag next week and/or signs that the two-thirds majority is fracturing. 

05 Mar 2025 - 07:50- ForexGeopolitical- Source: Newsquawk