Ahead of the Curve: A Contrarian Scenario Comes True on Remarkable German Fiscal Push

Arif Husain Head of Fixed Income and Chief Investment Officer, Fixed Income

Key Insights

• Germany’s fiscal expansion is set to boost global bond yields, reshaping market dynamics.
• Expect short-term volatility as Germany implements defense and infrastructure spending.
• In the long term, higher yields and steeper curves could benefit inflation-linked bonds and credit.

Germany’s sudden move toward planning more government spending on defense and infrastructure is an extremely meaningful moment in the global high-quality sovereign bond market and financial markets in general. I see a clear parallel with former European Central Bank President Mario Draghi’s commitment to do “whatever it takes” on monetary policy to preserve the euro during the European sovereign debt crisis in 2012. Tomasz Wieladek, our European economist, makes the case that the German spending boost may be even more significant because fiscal expansion has longer-lasting effects than monetary policy.

Regime change crystalizes early‑year contrarian scenario

Let’s be clear about this—Germany’s fiscal plans represent a significant regime change in financial markets. This solidifies one of the contrarian scenarios that I outlined in January in “Consensus is totally consensus—a contrarian’s strategic scenarios.” At the beginning of the year, the market’s one-sided consensus view was for continued U.S. exceptionalism as Europe struggled to grow. Instead, fears of the negative impact of tariffs have triggered concerns about U.S. growth, while the eurozone has outperformed expectations. Germany’s planned fiscal stimulus would only expand this outperformance.

Germany will need to issue more government bonds to fund its fiscal expansion, though its debt-to-gross domestic product (GDP) ratio will likely still be far lower than for other eurozone countries. Bund yields quickly adjusted much higher following the early‑March news from Germany. 

The move also pulled yields up across most global high-quality sovereign debt as investors adjusted their expectations for supply and demand relative to the yields available on each country’s bonds. I expect this trend, driven by fiscal expansion, to continue. 

"Let’s be clear about this—Germany’s fiscal plans represent a significant regime change in financial markets. 
 

Yields set to rise and curves steepen  

I still firmly believe that long-maturity developed market government bond yields are heading significantly higher—potentially to 6% on the 10-year U.S. Treasury note in the next 12 to 18 months—as Germany joins the growing list of governments that need to issue more debt to fund rising deficits. This means competition for funding is going to become even more challenging. Yield curves also have plenty of room to steepen as developed market central banks outside Japan are expected to keep rates at their current levels or cut further, which would anchor short-maturity yields while longer‑maturity yields would increase as stimulus fuels growth.

But expect short-term volatility

But the route to higher yields and steeper curves will undoubtedly be bumpy in the near term. I expect some stumbling in Germany’s actual implementation of its expanded defense and infrastructure spending. Even if all goes relatively smoothly, the fiscal expansion won’t impact the eurozone economy until the second half of 2025. And short-term eurozone sentiment is very negative because of the Trump administration’s trade wars.

The same tariff-induced uncertainty and drag on global trade will limit U.S. growth in the near term. The new U.S. administration’s Department of Government Efficiency (DOGE) cuts to the government workforce are another major factor holding back the U.S. economy and probably restraining yield increases at the long end of the Treasury curve, at least for the next few months. 

In the longer run, I believe there is a distinct path to higher bond yields and steeper curves as three of the major levers of the world economy—the U.S., Germany, and China—are all likely to provide stimulus to support their economies. This would be positive for global growth, boosting risk assets. In fixed income, inflation-linked bonds and credit may outperform in this environment. 

Risks to view center on supply/demand factors

Where could I be wrong? The risks to this view center on the supply/demand relationship for U.S. Treasuries. For one, the Federal Reserve stopping quantitative tightening would restore a major source of demand to the market, pressuring yields lower. A change in banking regulation that encourages banks to hold more treasuries, would also be a catalyst for demand if it happens. On the supply side of the equation, if the U.S. Congress fails to pass legislation extending tax cuts, the Treasury Department would need to issue less debt. 

But on the whole, I believe Germany’s plan for meaningful fiscal spending is a game changer, and that investors should consider taking action to position their portfolios for higher yields and steeper curves.

"In the longer run, I believe there is a distinct path to higher bond yields and steeper curves.... 
 

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