One week / one topic: Whatever it takes. Again.

What happened?

Friedrich Merz – whose CDU/CSU alliance finished first in the recent German federal elections – just blew everyone out of the water with a massive announcement:

• Germany will allow for hundreds of billions of euros in defense and security outlays by amending its constitution and removing fiscal spending limits

• Another €500 billion in infrastructure investments will fund transportation, energy grids, and housing over 10 years

After many years of resisting the message from financial markets and foreign leaders – ‘Dear Germany, you can afford to spend much more than you currently are… and you probably should.’ – the move finally came, and it came in size.

Just last week the ‘whisper number’ was €200 billion, but in the end the announced measures in aggregate total just shy of €1 trillion.

Merz even quoted Draghi’s ‘whatever it takes’ formula, and we know how powerful that proved to be last time around…

Sluggish economic growth, a protracted loss of manufacturing competitiveness vs China and – finally – the metaphorical slap in the face from JD Vance at the Munich Security Conference… it all proved to be too much to remain unaddressed.

How do you say ‘challenge accepted’ in German?

As an immediate consequence of this announcement, Bund yields jumped the most since the 1990 heydays of reunification:

Other European bond yields also jumped in sympathy – ‘Hey, if Germany is finally loosening the purse strings… why can’t we?’ – also as the European Commission clearly signaled the intent to relax fiscal constraints to address what is perceived as an existential threat.

Meanwhile, European equities continued to outperform and the DAX remained set on its torrid run.

What should investors make of all this?

Is it all ‘already in the price’, or is this just the beginning of a transformational change?

Our observations

• Fundamentals: European equities remain significantly cheaper than US ones, even after adjusting for ‘US exceptionalism’ and liquidity premia. As European companies also ramp up share buybacks, they still look compelling even after the recent outperformance.

• Price action: German (and European) yields repriced massively higher. While we have no quarrel with the direction of travel, the size of the move could be overdone at some point… but probably not yet.

• Investor beliefs: The sea change is observable, but foreign investors might take some time to come around to it after writing off European assets for so long….

So what?

The talk about recent developments representing a structural change for Germany – and therefore Europe – seems justified.

I agree with my colleague Wolfgang’s assessment: “Investors can say goodbye to the German austerity and fiscal discipline. The rules of the game have changed.”

And yet – with a macro hat on – there are at least two key considerations that come to mind.

Price action for European assets – stocks, bonds, FX – has indeed been very sharp, with 5-sigma weekly moves in some cases.

But we would reasonably assume that prices do not perfectly and instantaneously adjust to discount all the possible scenarios, especially when there is such a large political component to the developments at hand.

Also, all the attention being paid to what’s going on in Europe might distract investors from observing the now very noticeable underperformance of US equities.

‘Buy American’, anyone?

Mood music: The Ramones – Blitzkrieg Bop