Germany Announces Historic Fiscal Stimulus Plan
Germany dropped a bombshell today as the incoming German government announced an unprecedented fiscal stimulus plan. This includes establishing a €500 billion special infrastructure fund, providing "unlimited" support for defense spending, and permitting local governments to increase borrowing. Altogether, the total scale of this plan could exceed €1 trillion.
The magnitude of Germany's fiscal stimulus plan is on par with the historic impact of the reunification of East and West Germany over 35 years ago. In the short term, this initiative aims to "provide a safety net" to prevent further economic deterioration. From a mid-term perspective, the plan is expected to bring a "paradigm shift" to Germany's economic growth model. With increased defense expenditure in the coming years and annual domestic capital spending rising by 1%, Germany's growth prospects could approach 1.5–2%. This marks a significant transformation in the country's economic trajectory.
Immediate Impact on German Bond Market
The shift in Germany's fiscal policy had an instant impact on the German bond market. As seen in the chart above, following the announcement, yields on 10-year German bonds surged nearly 20 basis points, marking their highest point this year.
Bank of America has forecasted that strengthened mid-term growth prospects for Germany, coupled with increased bond and treasury supply, may push 10-year German bond yields higher than previously anticipated. The yields are expected to reach above 2.75% and stabilize around 2.5% in the medium term, up from the earlier projection of 2%. Additionally, the 10-year swap spread is predicted to narrow by approximately 10 basis points.
ECB Interest Rate Cuts and U.S. Economic Warning Signs
Meanwhile, the European Central Bank (ECB) announced its latest monetary policy decisions, which aligned with market expectations. The ECB cut deposit facility rates by 25 basis points, lowering them from 2.75% to 2.5%. This marks the sixth rate cut since June of last year. Additionally, the ECB reduced the main refinancing rate from 2.9% to 2.65% and the marginal lending rate from 3.15% to 2.9%.
The rate cut announcement led traders to adjust their expectations for further ECB rate reductions. The market now anticipates an additional drop of 41 basis points by the end of the year.
Across the Atlantic, troubling signs are emerging from the U.S. economy. Within just two working days, the Atlanta Federal Reserve’s GDPNow forecast for U.S. GDP growth in the first quarter of 2025 was slashed by 510 basis points—from a projected growth of 2.33% to a contraction of 2.825%. Monday's GDPNow forecast of a 2.83% contraction marks the worst GDP projection for the U.S. since the onset of the COVID-19 pandemic in 2020.
A Rapid Downturn in U.S. Economic Forecast
Only last week, the GDPNow model predicted a 1.5% GDP contraction for Q1. Just a month ago, it forecasted growth of 3.9%. In the span of one month, expectations swung from robust economic growth to a recession—an alarming shift.
The sudden reversal coincides with the transition of leadership in the U.S. government, with President Trump taking office. Could it merely be a coincidence that the U.S. economy faces a downturn the moment Trump gains control?
As non-farm payroll data is set to be released tomorrow, is there still hope? Perhaps the "landmines" left behind by the previous administration are about to explode. Now, Trump must face the challenge head-on.
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