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EUR/USD has extended its gains this week to 3%, thanks to a combination of a US economic slowdown, and an historic shift in the European fiscal environment.
So far, this is the biggest weekly gain since November 2022. GBP/USD, meanwhile, is up 6% since its trough in January.
The European Commission has unlocked around €800bn in spending through an escape clause to the Stability and Growth Pact, while an agreement between the CDU/CSU and the SPD in Germany will create a €500bn infrastructure fund and amend the debt brake to allow unlimited defence spending.
The debt brake reform is a watershed moment for Germany, and what it symbolises is as important for markets as the spending itself.
It is an open acceptance that Europe is at a turning point and that its fiscal shackles have led to structural underinvestment and economic stagnation.
Is it the gamechanger that switches Germany from a drag on activity to an engine of growth? It won’t be a magic bullet, but it is definitely a step in the right direction. Many of the economic headwinds remain: high energy prices, Chinese competition, and Trump’s economic war against his allies. Meanwhile, the downside to extra fiscal spending is weaker fiscal sustainability. While Germany has plenty of space to rack up some more debt, the likes of France and Italy do not have the same privilege, and a fiscal risk premium might put the reins on a stimulus-fuelled rally.
The US-Europe macro divergence narrative that pushed the dollar to multi-year highs two months ago is undoubtedly still there, but it has diminished significantly in a short time. Trump’s lightning pace of policy change and the perpetual trade uncertainty are paralysing businesses and depressing consumer spending, while the prospect of large fiscal stimulus in Europe should accelerate the post-pandemic economic recovery.
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