A European paradigm Shift

A European paradigm shift

This week will be remembered by a lot of market participants as the start of a new era in terms of fiscal and defense spending by Germany and overall, in Europe. On Tuesday, we experienced a historic event where we saw the biggest widening of German government yields since 1990, with volatility remaining at its highest.

The week started again with the US implementing tariffs across Canada, Mexico and China, 25% and 20% respectively. Canada and China retaliated immediately with the latter imposing a 15% tariff on US goods and banned exports to certain defense companies in retaliation for the additional 10% tariff announced by President Trump. The main event of the week though was across the pond.

The German incoming Chancellor Metz is opening the door for a EUR500bn fiscal package which will include defense spending, and he is also pushing for Europe to relax fiscal rules with regards to overall spending. This is a major shift in terms of fiscal policy within Europe and was a big surprise to the market. On the back of that, we had some major moves across asset classes. First and foremost, 10yr German government bonds moved 30bps wider in 24 hours to a wide level of 2.93%, the fastest move in yields since 1990. Moreover, EUR currency appreciated 4.3% against the dollar, moving towards the 1.08-1.085 level with a lot of strategists predicting that this move is not finished yet. European equities remained anchored, keeping their YTD gains with DAX Index being the outperformer, currently up 15.5% year to date. The rhetoric here implies that the fiscal spending will create a GDP growth of 1.5% next year and at the same time can be deemed inflationary, hence the move higher in yields across European government bonds. On Thursday, the European Central Bank cut their deposit rate by 25bps to 2.5% as expected and refrained from giving a clear direction in upcoming meetings. The Q&A session with President Lagarde did not really inspire any confidence with the overall rates market sustaining high volatility levels. The market is currently pricing another 47bps of cuts by year end with a live ECB meeting in April. 

In terms of data there was a mixed picture across Europe with European CPI coming slightly higher than expected but lower from January’s reading, 2.4% vs 2.3% . PMI figures across Europe show a sideways movement with manufacturing still implying a drag in growth. On the technical side we saw a major compression between US 10yr government bonds and German 10yr Government bonds as depicted by the figure below.

Looking ahead…

There was a lot of new news this week and the market is still digesting the impact and timing of them. In the US, the tariff saga and unexpected news from President Trump is a daily incidence with the market showing fatigue from the current regime of uncertainty. I am pointing out that year to date the US equity indices are down on the year, circa 2.5-4% but more importantly they are lower than the day that President Trump was elected with a Make America Great Again motto. What lies ahead remains to be seen as the market is currently pricing a 30-40% chance of a US recession. Late on Friday, we are expecting US Non-Farm payrolls and an unemployment rate which may give an indication of where the labor market stands in the US. Given the uncertain regime we stay nimble but invested in a balanced diversified approach with a good cash balance to take advantage of any potential dislocations in the market. April is also going to be a very volatile month as US reciprocal tariffs are supposed to take place so having free ammunition to invest seems to be the most prudent strategy for now. One thing for sure is that volatility opens up opportunities and hence active portfolio management is necessary to withstand all the market moves.

Written by: Michael Konstantinou, Senior Portfolio Manager