The announcement by Germany's conservatives and social democrats of an exceptional €500 billion financing plan for infrastructure and economic competitiveness, and a significant increase in defense spending, both made possible by a proposed unprecedented relaxation of the so-called “debt brake” rules enshrined in the German constitution, caused an unprecedented surge in long-term rates over the last 2 days in the eurozone.

Germany needs to accelerate its defense spending and boost its economy, while there are still political steps to be taken, the project is both larger in size and faster in execution than the financial markets had anticipated.

At the same time, the European Commission is considering amending the fiscal stability rules for member states to enable the financing of military rearmament efforts in response to the risks of withdrawal of the US military umbrella. The initial round of funding, which would not be subject to fiscal stability constraints, is expected to amount to €150 billion.

The market reaction was swift, as illustrated by the chart below, showing the evolution of the 10-year Eurozone swap rate over the past year.

A surge of this magnitude in long-term rates within 48 hours has not occurred since the introduction of the Euro in 1999.

Against this backdrop of a shock to long-term rates, the ECB nevertheless decided on Thursday March 6 to cut its key rates by a further 0.25%, bringing the deposit rate to 2.50%. This cut had long been anticipated. However, during the press conference, the ECB's tone reflected increased caution regarding further rate cuts in 2025, as recently advocated by some governors, most notably Isabel Schnabel in Germany.

At the same time, U.S. rates showed little movement, and expectations of lower short-term rates even strengthened. This discrepancy in the evolution of long rates on both sides of the Atlantic contributed to the surge in the EURUSD FX rate from 1.04 to 1.08 in the last few days, an appreciation of the Euro that will not help the European economy in the short term.

Given this context, financial market volatility is expected to remain very high throughout March. Caution and responsiveness are more essential than ever.