Europe just broke the game wide open

The biggest move in 80 years

We need to start with what is probably the biggest structural change Europe has seen since the formation of the European Union to its biggest member – Germany.

For the first time in 80 years Germany’s Bundestag has voted to lift the country’s “debt brake” to allow the expansion of major defence and infrastructure spending under new leadership of incoming Chancellor Frederick Merz.

We need to illustrate how much spending Germany is going to do in defence it is up to €1 trillion over the forward estimates. 5 billion of which is to support Ukraine for this year and to continue to put European pressure on Russia. It’s also a country it has been highly sceptical of stimulating itself having suffered through the Weimar
government of the 1920s and 30s that led to hideous hyperinflation and drove the country to political extremism.

It is also clearly in response to Washington’s change of tact regarding Europe and the war in Ukraine. As it is now clear that Europe who need to defend itself and that NATO is becoming a dead weight that can no longer be relied upon.

Couple this with what the EU is doing itself. Last week we saw the head of the EU Ursula von der Leyen, delivered a speech that stated the continent needed to: “rearm and develop the capabilities to have credible deterrence.” This came off the back of the EU endorsing a commission plan aimed at mobilising up to €800 billion in investments specifically around infrastructure and in turn defence. The plan also proposes to ease the blocs fiscal rules to allow states to spend much more on
defence.

If you want to see direct market reactions to this change in the continent’s commitments – look no further than the performance of the CAC40 and DAX30. Both are outperforming in 2025 and considering how far back they are coming compared to their US counterparts over the past 5 years – the switch trade may only be just
beginning.

What is also interesting it’s the limited reactions in debt markets. The 10-year Bund finished marginally higher, though overall European bond markets saw limited movement. Bonds rallied slightly following confirmation of the German stimulus package. Inflation swap rates were little changed, while EUR swaps dipped, particularly in the belly of the curve.

EUR/USD ticked up 0.2% to $1.0960. Hopes for a potential Russia-Ukraine cease-fire also offered some support to the euro but has eased to start the weeks as Russia looks to break the deal before it even begins.

Staying with currency impactors –

The US saw a range of second-tier U.S. economic data releases last week all came in stronger than expected. Housing starts jumped, likely benefiting from improved February weather. Industrial production rose 0.7% month-over-month big beat considering consensus was for a 0.2% gain while manufacturing jumped 0.9%. Import and export prices also exceeded forecasts, prompting a slight upward revision to core PCE inflation estimates, mainly due to higher-than-expected foreign airfares.

These upside surprises led to a brief sell-off in treasury bills but yields soon drifted lower as equities struggled.

Looking ahead to the FOMC decision, expectations remain for the Fed to hold steady. Chair Powell has emphasised that the U.S. economy is in a "good place"
despite ongoing uncertainties and has signalled there’s no rush to cut rates.

The Fed’s updated projections are expected to show a slight downward revision to growth, a more cautious view on GDP risks, and slightly higher inflation forecasts. As for rate cuts, the median expectation remains two 25bps cuts in 2025 and another two in 2026, with markets currently pricing around 56bps of easing next year.

All this saw the U.S. dollar trade mixed against G10 currencies as local factors took
centre stage.

Despite a weaker risk tone in equities, the DXY USD Index edged down 0.1%. The Aussie and Kiwi dollars softened (AUD/USD -0.3%, NZD/USD -0.4%) as risk
sentiment deteriorated.

The AUD will be interesting this week as we look to the budget that was never meant to happen on Tuesday. Considering that we are within 10 weeks of a certain election, the budget really is not worth the paper its written on as it will likely change with an ‘election’ likely to be enacted straight after the new government is sworn in.

That said, the budget is likely to show once again that Canberra is messing at the edges and not taking the steps needed to address structural issues. The AUD is likely to fluctuate on the release and then find a direction (more likely to the downside) over the week as the budget shows the soft set of numbers with little or no
change in the interim.

Finally, the rally of the yen appears to be over as it continues to weaken. USD/JPY climbed from Y149.20 in early Tokyo trade to around Y149.90 as the London session got underway. With CFTC data showing significant long yen positioning, some traders likely unwound short USD/JPY bets ahead of the BoJ decision. Other JPY pairs moved in tandem with USD/JPY. But whatever is at play out of Japan – the rally of the past 6-7 months looks to be ending and with USD/JPY facing the magic Y150 mark – will the BoJ step in like it did last year? Will the market look straight past it again? Or will we see a completely different trend?