The past week marked a watershed moment for the eurozone, potentially signaling a fundamental shift in European economic policy. The coalition set to assume power in Germany announced a massive fiscal package — ranging from 12% to 18% of GDP — which includes the creation of a €500 billion infrastructure fund and the relaxation of debt constraints on defense spending, representing a break from its traditional Exportweltmeister model.
The Germans are having a “Jesus moment,” recognizing the need to shift from being a capital exporter — Exportweltmeister — to prioritizing domestic investment. This marks the beginning of a macroeconomic regime change, with EUR/USD acting as a key transmission mechanism.
Betteridge’s Law of Headlines suggests that if a news article poses a question in its headline, the answer is typically “no.” Similarly, the placement of the question mark in the title of the article I wrote for Enterprising Investor in September 2022, “Is the Euro Uninvestable? The FX Question du Jour,” was intended to emphasize that uninvestable is a transitory term.
Standing here today, one might be forgiven for thinking that Friedrich Merz, Germany’s Chancellor-in-Waiting, had my article conveniently pinned alongside The Draghi Report on EU Competitiveness on his policy board. More likely, of course, it’s a case of aligned thinking — reinforced by the huge wake-up call from Trump 2.0.
The article I wrote back in 2022 also argued that the European Central Bank (ECB) should do away with the Atlas Syndrome of assuming the role of a fiscal authority and allow for market-driven price discovery in EUR-denominated bonds. That shift is now taking place.
The ECB has jettisoned the Asset Purchase Program (APP) and the Pandemic Emergency Purchase Program (PEPP) and is currently on the path of Quantitative Tightening (QT). It’s very encouraging to see that the phrase “whatever it takes” is now coming from Germany’s Chancellor-in-Waiting rather than the President of the ECB.
As Lenin famously said, “There are decades where nothing happens; and there are weeks where decades happen.” While this quote may be overused, it certainly justifies being invoked considering the magnitude of the market moves we saw last week. Bund yields saw their most significant moves last week since the fall of the Berlin Wall, with the 10-year UST-bund spread (US Treasury vs. German bund) compressing by around 44 basis points, bringing us full circle to relative asset pricing and the Portfolio Balance Approach as key determinants of EUR/USD performance. It’s no surprise, then, that EUR/USD surged from the 1.04 to the 1.08 handle last week.
With a greater focus on domestic investment, the eurozone’s net international investment position (IIP) surplus should shrink and possibly even turn into a deficit. Of course, there’s many a slip between the cup and the lip. The fiscal package must pass through both the Bundestag and Bundesrat. And Germany’s deep-rooted Schwarze Null (black zero) culture of maintaining a balanced budget must be overcome at multiple levels. Nonetheless, market expectations are now aligned with the idea that Germany has truly reached an inflection point.
Year-to-date, a notable divergence in trajectories has emerged with US and German yields, with US yields declining (10-year UST yield down by around 30bps) while bund yields are rising (10-year bund yield up by around 50bps), influencing cross-border portfolio rebalancing and EURUSD performance.
On the other side of the pond, we are reminded to take President Donald Trump seriously but not literally. However, for market participants, this translates into heightened uncertainty. Recent academic literature on financial markets and decision-making in general emphasizes the distinction between risk and uncertainty.
Risk arises in situations where outcomes and probabilities are well-defined. Uncertainty and ambiguity, on the other hand, refer to situations where outcomes and probabilities are unclear or unknown. These ideas, first formulated by thinkers like Frank Knight and John Maynard Keynes about a century ago, have only been formally detailed in academic literature over the past thirty years or so. They are particularly relevant in the Trump 2.0 era, which is beginning amid deep uncertainty and ambiguity.
Trump’s “break first, ask questions later” approach to government spending and the persistent policy uncertainty surrounding tariffs is fueling concerns over growth and employment. These topics, of course, warrant a more detailed article on uncertainty versus risk , one that would also likely include the word uninvestable followed by a question mark.
Summary
The impetus in Germany to drive a fiscal policy pivot, set against the backdrop of the ECB’s ongoing normalizing of monetary policy, has fueled historic market moves. Last week, bund yields experienced their most significant shift since the fall of the Berlin Wall, with the 10-year UST–bund spread compressing by 44 basis points and EUR/USD surging from 1.04 to 1.08.
As Germany recalibrates toward domestic investment, the eurozone’s net international investment position (IIP) surplus could shrink or even turn into a deficit. Germany’s political clarity in enacting policy change — despite the challenge of breaking from the black zero culture — stands in contrast to policy uncertainty across the Atlantic. With the return of Trump-era unpredictability — marked by policy ambiguity and a “break first, ask questions later” approach — investors are grappling with a landscape where risk and uncertainty blur.
Amid the evolving dynamics on both sides of the EUR/USD equation, investors must weigh the potential for long-term transformation against short-term noise and consider whether this marks a trading regime with some legs or just another chapter in market volatility.
