‘Whatver it takes’. With this phrase the future Chancellor of Germany and leader of the CDU, Friedrich Merz, invoked Draghi after his pact with the SPD on Tuesday night. This comparison is no accident, because these words marked a turning point in the euro crisis, the decision that both matches have made is a complete change for Germany, in the middle of the crisis and, in the second instance, for the entire European debt market. The reason is that the two main games of Germany have agreed to end the ‘sacred debt rule’.
The debt brake that operated so far was a constitutional reform undertaken by Angela Merkel in 2009, in the worst of the euro crisis. This measure prevents the government from having a deficit of more than 0.35%. This had a slight nuance with Covid, where a special vehicle was created that was exempt from this rule and the Ukraine War. However, none of these norms allowed precisely a Germany to spend much more than he entered. The Central European country barely has 60% of debt over GDP and in 2023, when the industrial crisis materialized the Constitutional Court knocked down some budgets that the coalition government for little tomb.
But what has Merz approved exactly (in the absence of the Bundestag vote in favor)? This could be summarized in three key points. On the one hand, a 500,000 special vehicle is created for infrasturcutra spending that will be exempt from the limit. However, this is just the ‘incoming’. The key comes from now on all defense expenses exceeding 1% of GDP will be exempt from the debt brake. But this is not all, so far the ‘Landers’ (their autonomies) will be released from the debt brake.
From Commerzbank they comment that, especially the second point Porovca that “the debt brake loses virtually all its binding force.” The German government planned so far an expense of 1.2% of GDP in defense, according to the calculations of the German bank that, as it gives them 10,000 million euros of margin to spend outside the special vehicle. However, the idea is that defense spending increases up to 3.5% of GDP to be able to correctly protect European borders and assume US demands and its ‘abandonment’ of Ukraine. According to Commerzbank if this process is fulfilled, we would be talking about every year Germany would add 2.5% to its GDP debt. This, which may seem to countries like Spain where it reaches 104%, represents a radical change for a country that practically did not emit new bonds with the limit.
This will allow the German economy to face its crisis better with more expense and stimuli. The German industry comes in contraction since 2022, with the Ukraine War. A precise energy shot canceled profitability and, although later they relax, the entire model was in crisis. Lower exports due to China’s weakness and in a more restrictive environment on the part of the central banks added to those structurally higher prices. This has caused a recession in 2024 with a 0.2% drop in GDP.
“These impressive plans highlight that the authorities are thinking great and that the financing capacities could be limited in the coming years,”
Now the one that arises as a new coalition government will seek to reactivate the ‘European locomotive’ with stimuli. While the SPD seeks to increase social spending, consensus is based on that great infrastructure fund, but also on a higher defense expense. In any case, this flexibility has been seen by the country’s companies as a great invitation to a new economic cycle.
Proof of this is that the market is celebrating it with authentic euphoria and proof of this is the Dax flying 3.5%. On the other hand, very diverse actions lead the European stock markets with Deutsche Bank shooting 8.39%, Siemens Enerly 8.18%, Delivery Hero 7.4%, Lufthansa 6.56%, Commerzbank 6.32%, BASF 6.18%, Rheinmettal 4.9%, BMW 4.3% 4.18%, Bayer 4%, Puma 3.8%, Porsche 3.67%, Mercedes 3.5%and Volkswagen 2.55%.
A radical change for Europe
However, where this change is being seen most is in the European markets of fixed income. Investors now expect a great renewed offer of German German bonds, something that has fired their yield by 7.68% to 2.67%. This is the greatest increase since 2022 and has also preceded a climb of 0.6% in the euro in its exchange with the dollar. The French bonus yield also rises strongly to 3.35%, Spanish to 3,295%and Italian to 3,689%. “These impressive plans highlight that the authorities are thinking big and that the financing capacities could be limited in the coming years,” said Christoph Rieger, head of type and credit investigation in Commerzbank AG.
This is particularly important since the change in the ‘debt brake’ marks a turning point for the entire debt market in Europe. Something particularly important given the doubts that exist about the sustainability of the deficits of many EU countries already indebted as France (5.5%of GDP), Spain (3%) or Italy (3.5%). The situations of France and Italy that have a very tense situation with 110% about GDP and 135% on GDP respectively stand out.
The reason that Germany is so important is that the German Bund is the reference of the debt market, the anchor on which the entire market is built. Daniel John Gray, from Orbex, comments that flexibility can generate that “Germany would increase its debt, something that could leave investors less confidence in their great solvency. Germany’s reference interest rates could rise until they approach those of other countries in the euro area that have greater debts.” The expert comments that the economic impact is “uncertain”, given that the interest rates of the ECB have a lot to say on this issue, but “unlike short -term interest rates, which usually sustain the price of a currency, higher long -term interest rates would probably weigh on the euro and hinder the ECB their work of relieving financing costs. The greatest uncertainty could be another factor that despite the euro.”
From Capital Economics they comment that the ECB could ‘save’ the debt market with aggressive type cuts. “While the debt brake puts pressure on bonds in the face of higher deficits, monetary policy can compensate for this, if the ECB cuts more the types of what the market expects.” If this is so, the firm estimates that the yields may fall in the case of the BUND to 2.5%.
From Tower Rowe Price, they comment on Financial Times that the impact would be direct since there would be a greater supply of BUNS. “Even modest increases in the offer can lead to great modifications since the BUND is a very scarce asset.” In that sense, he comments that “a debt brake reform would have a significant impact on the yields of German bonds and, therefore, in global bond markets.”
“If a debt brake reform is implemented, you may increase the yields of other government bonds”
In summary, “if a debt brake reform is implemented, you may increase the yields of other government bonds, which would make it difficult to return to a sustainable path of public debt. Even the United States could feel the effects of the expansive wave.”
A German bonus that offers more yields and a greater supply can be a real lighthouse for investors in fixed income, the bund being the safer fixed income asset on the continent. In that sense, the slightest demand can affect the debt of countries such as Spain, France or Italy, which would now be more exposed and have to pay more for their liability. From Citigroup they commented before the agreement that only with 0.35% of the Germanic bonus emission is 139,000 million euros. A figure only surpassed by France. Given the dimensions of the German economy, a greater increase would flood the market.
In any case, greater yields do not put the AAA rating of Germany at risk, since the same ‘rating’ agencies have been blessing ‘more lax standards for months. In his latest Fitch report, he commented that “although the debt brake reflects the authorities’ commitment to fiscal prudence, which constitutes a strength of the qualification, moderate growth, which has slowed down the reduction in debt, is a weakness of the qualification.” In that sense, “a possible reform of the debt brake to allow greater government investment could increase flexibility to implement countercyclical policies and respond to structural challenges.”
This adds to a Europe that will spend more more, as indicated by the European Commission. This same Monday Von der Leyen announced a plan of 800,000 million euros for military spending relying on three legs: the suspension of fiscal rules for defense, 150,000 million in loans and redirect items of the community budget. In summary, deficit control standards from Brussels will be more lax to allow this great rearma. A process parallel to that of Germany but promises great changes that will have its echo throughout the continent.
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