On 4th March, the recent German election winner parties CDU/CSU and SPD agreed on a massive fiscal expansion, breaking the brakes of the constitutional debt brake. In our view, the proposed fiscal package amounts to the most significant fiscal regime shift since German reunification.Germany's own proposed measures are EUR 500bn special purpose vehicle for public infrastructure investment & reform of the debt brake rule to exempt any defence spending over and above 1% of GDP, effectively permitting open-ended borrowing for defence. EU too has responded by proposing €150 billion in loans to boost defense spending as well as allowing countries to use their national budgets to spend an additional €650 billion on defense over four years without triggering budgetary penalties. Assuming the EU & German plans are spread over a four-year horizon that implies a total of up to €250bn per year of new fiscal support across the EU for a combination of infrastructure (Germany) and defence (pan-EU and Germany) – i.e., almost 1.5% of EU GDP per year. We now expect 1.4% growth in EU in 2026 vs our previous forecast of 1% y-o-y. For Germany, we now expect 1% growth in 2026, double our previous forecast of 0.5% y-o-y. The new plans imply higher fiscal spending leading to 2026 HICP inflation and core HICP inflation being on an average 20bp higher than previously; we now forecast both to average 2%. To us, it seems like Trump has decided that one way to reduce US fiscal spending is to push it’s allies to take responsibility of their security needs. This bodes well for the UST yields but not so much for USD. As US gives up it’s security umbrella, other nation’s spending will push their growth higher and their FX too against USD. But this is what Trump wanted in the 1st place. Lower rates & weaker USD. Hence, he has killed two birds with one stone. Above assumptions imply a less dovish ECB with our terminal rate expectation to be now at 2-2.25% (current policy rate at 2.5%) than the previous 1.5-1.75%. Hence, we expect only 1-2 more 25 bps cut in REMCY25. We see 10year German Bunds at 3.25% (CMP at 2.83%) by end CY25 and EURO at 1.15 (CMP 1.0830) by end CY25
