Update Bonds: Bund shockwave
Germany’s ‘whatever it takes’ moment shook the European sovereign debt market. The incoming German government announced an unprecedented three-pronged fiscal package, which has the potential to substantially alter the outlook for German growth.
The plan features three key levers: 1) a EUR 500 billion infrastructure fund, 2) spending on defence above 1% of GDP to be exempt from the debt brake and 3) German länder can now borrow up to 0.35% of GDP (previously zero). Much will depend on the timing and composition of the new spending. Although the plan’s deployment could be implemented more or less quickly, markets are in favour of fast execution. This could, in the short term, force more sovereign debt supply, keeping in mind that to lure investors additional (higher) yield needs to be offered. Germany's fiscal plans have far-reaching implications beyond its borders, affecting not only the broader European sovereign market but also Japan, Australia and New Zealand.
On Thursday, the European Central Bank (ECB) reduced its deposit rate by a quarter point to 2.5%. The ECB indicated that its cutting phase may be drawing to a close, as inflation cools and the EU economy digests seismic geopolitical shifts. This may further feed speculation that the ECB is contemplating a “time out” from further cutting, as it is likely that the 2% inflation goal is within reach.
Across the Atlantic, US Treasury yields have experienced a moderate increase, reaching 4.3% and continuing their recent upward trend amidst ongoing uncertainties surrounding tariffs and payrolls.
In this extremely volatile market, European investment-grade spreads showed resilience versus the Bund move and narrowed by 6 basis points (bps) to 86 bps, their lowest level since 2021. While not directly influenced by the European bond market, US investment-grade spreads also tightened slightly to 84 bps (below their historical average), but faced pressure in late February due to economic growth challenges.
European high-yield bonds tightened by 15 basis points to 271 bps, the lowest level since 2018, showing even less sensitivity to a potential increase in German debt. US high-yield bonds, after widening in late February, tightened by 10 basis points to 283 bps, though they remain 25 bps above their lowest point in 2025.
Germany's 'fiscal bazooka' is a generally supportive factor for the economy and corporates. The threat of tariffs, however, remains a significant risk that could hinder growth.
Despite the attractive yields in riskier bonds, caution is advised due to potential impacts from geopolitical uncertainty, rising interest rates and high valuations. Preference is given to higher-quality bonds, which are likely to perform well amid limited European growth. Longer maturities in Europe continue to be appealing, but a cautious approach is recommended in light of the recent announcements from Germany.