"Whatever it takes" 2.0? At least the market believes it!

An important perspective in macroeconomic research is to study the relationship between total supply and total demand. For example, when household consumption is weak, the government often needs to increase its leverage to boost total demand. From an international analysis perspective, the exchange rate is often an important regulator for adjusting demand and supply. For instance, when domestic demand in a country is weak, a depreciation of the exchange rate can stimulate exports, thereby achieving the goal of boosting total demand.

It is believed that President Trump is not an advocate of these theories, but he has indirectly stimulated fiscal expansion in Europe, especially Germany, through fiscal tightening in the United States. Ultimately, the demand from fiscal sources may not have significantly shrunk, but a certain rebalancing has been achieved through interest rates and exchange rates.

Germany's incoming Chancellor Merz stated that the major central political parties have also agreed to launch a €500 billion infrastructure fund for investment in priority areas such as transportation, energy grids, and housing. Stimulated by this plan, German government bond yields soared, with the 10-year German bond yield surging by 30 basis points in a single day, marking the largest single-day increase since 1990. The 2-year and 30-year German bond yields also rose by more than 20 basis points.

Stimulated by the surge in German government bond yields, the euro also surged, with the exchange rate against the US dollar approaching the 1.08 mark. After a continuous decline in the US dollar index in the first two months of this year, it fell again by more than 3% in the first week of March. From the perspective of the yield spread between US and German bonds, the euro seems to be pointing towards the key level of 1.10.

Although these market movements are highly related to geopolitical factors, they also reflect that the so-called "demand vacuum" and "supply vacuum" do not truly and long-term exist. Although the United States has reduced its fiscal spending abroad due to its own debt repayment needs, this gap has quickly been filled by Germany—at least that is how the market expects it.

To some extent, this also means that many directional changes in policy may have been brewing for a long time. On one hand, changes in policy direction require some time to materialize; on the other hand, some directional changes may occur due to seemingly random events and timing.

Meanwhile, the financial market has once again shown a strong reaction to marginal changes. The surge of the euro means that the previously constrained US dollar bulls may further turn against it, which is positive news for non-US assets, and Hong Kong stocks have become one of the undeniable beneficiaries.

An important perspective in macroeconomic research is to study the relationship between total supply and total demand. For example, when household consumption is weak, the government often needs to increase its leverage to boost total demand. From an international analysis perspective, the exchange rate is often an important regulator for adjusting demand and supply. For instance, when domestic demand in a country is weak, a depreciation of the exchange rate can stimulate exports, thereby achieving the goal of boosting total demand It is believed that President Trump is not a proponent of these theories, but he has indirectly stimulated fiscal expansion in Europe, especially Germany, through fiscal tightening in the United States. Ultimately, the demand from fiscal policy may not have significantly shrunk, but it has achieved a certain rebalancing through interest rates and exchange rates. Trump has called for the U.S. to cut spending and reduce security commitments to allies.

However, this "vacuum" did not last long. Out of defense needs, Germany's incoming Chancellor Merz, who has long adhered to strict fiscal discipline, stated that Germany will amend its constitution to exempt defense and security spending from fiscal expenditure limits in order to "protect the country at all costs." This inevitably reminds investors of former European Central Bank President Draghi's resolute statement of 'Whatever it takes' during the height of the European debt crisis.

Merz also indicated that major central political parties have agreed to launch a €500 billion infrastructure fund to invest in priority areas such as transportation, energy grids, and housing.

Stimulated by this plan, German government bond yields soared, with the 10-year German bond yield surging by 30 basis points in a single day, marking the largest single-day increase since 1990. The 2-year and 30-year German bond yields also rose by more than 20 basis points.

With the surge in German government bond yields, the euro also advanced strongly, with the exchange rate against the U.S. dollar approaching the 1.08 mark. After a continuous decline in the dollar index in the first two months of this year, it fell again by more than 3% in the first week of March. From the perspective of the yield spread between U.S. and German bonds, the euro seems to be pointing towards the key level of 1.10.

Although these market movements are highly correlated with geopolitical factors, they also reflect that the so-called "demand vacuum" and "supply vacuum" do not genuinely and permanently exist. Although the U.S. has reduced its fiscal expenditure abroad due to its own debt repayment needs, this gap has quickly been filled by Germany—at least that is how the market perceives it.

To some extent, this also means that many directional changes in policy may have been brewing for some time. On one hand, changes in policy direction require some time to materialize; on the other hand, some directional changes may occur due to seemingly coincidental events and timing.

Meanwhile, the financial market has once again shown a strong reaction to marginal changes. The surge in the euro indicates that previously constrained dollar bulls may further turn against the dollar, which is positive news for non-U.S. assets, with Hong Kong stocks becoming one of the undeniable beneficiaries.

For U.S. bonds, they have risen in the short term due to the surge in German bond yields, but the pressure from economic data will still suppress the upward space for U.S. bond yields. This Friday's non-farm payroll data and next week's inflation data will further clarify the state of the U.S. economy for the market However, if the rise in U.S. Treasury yields is slower than that of German government bonds, the U.S. dollar may face more selling pressure. The Australian dollar, which has performed relatively poorly this year, may become the new darling of the market.

Authors: Zhou Hao, Sun Yingchao, Source: GTJAI Macro Research, Original Title: "CITIC Securities International Macro: 'Whatever it takes' 2.0? At least the market believes it!"

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