Germany’s chancellor-in-waiting Friedrich Merz announced plans for a major increase in defense and infrastructure spending. If passed by the German parliament, the plans would mark a significant fiscal shift that has the potential to boost growth and support Eurozone assets.
Yet uncertainty remains high, particularly around US tariff risks. In equities, we like structured strategies on the DAX and thematic approaches. The rise in bond yields offers an opportunity to lock in a source of durable income, in our view.
• Friedrich Merz, whose Christian Democratic Union (CDU) alliance won Germany's election—but who is still in talks about forming a coalition—vowed to do “whatever it takes” to defend Europe.
• He is seeking parliamentary approval to free up EUR 500bn for infrastructure spending and exempt defense spending over 1% of GDP from the “debt brake.”
• The DAX and the euro rose on the news, while Bunds sold off.
• If the package passes, government spending could increase by around a cumulative 20% of GDP over the coming decade.
• While the extra spending would take time to feed through, the pro-growth signal from the move could support consumer and business sentiment well before funds start to be deployed.
• We believe the plans have the potential to improve the investment outlook domestically and for the region. But uncertainty is high, especially given US tariff risks, warranting a selective approach.
• In equities, we recommend gaining exposure via structured strategies on the DAX or, more selectively, via our “Six ways to invest in Europe” theme. We also like Eurozone industrials.
• We view the rise in yields as an opportunity to lock in attractive yields in medium tenor quality corporate bonds.
• While a fiscal shift could benefit the euro over the medium term, we see risks of a near-term pullback in EURUSD amid US tariff threats.
Germany's DAX index rallied 3.4% on 5 March after CDU leader Friedrich Merz announced plans to boost government spending on infrastructure and defense. The index has risen 16% year-to-date, making it one of the world's best performing equity markets in 2025.
Higher German government spending could improve the investment outlook domestically and for the wider region—but risks remain, especially around US tariffs.
• Germany's “debt brake” is a rule introduced in 2009 to cap the government's structural budget deficit at 0.35% of GDP.
• The latest proposals would also extend the deficit allowance of 0.35% of GDP to German states (Länder), which currently must run a balanced budget, potentially doubling the government’s borrowing cap to 0.7% of GDP per year.
• The 30-basis-point rise in the 10-year Bund yield on 5 March was the largest one-day increase since German reunification in 1990.
• While additional government bond supply is a concern, we believe markets' initial reaction to the credit risk was overdone. In our view, Germany's fiscal profile is strong enough to shoulder the extra spending without losing its Aaa/AAA credit rating.
After years of underinvestment, plans to increase German government spending and reform the debt brake have the potential to improve the investment outlook domestically and for the wider region. Given elevated uncertainty in the near term, we favor a selective investment approach. In equities, we like structured strategies on the DAX and thematic approaches to position for potential positive catalysts. We recommend locking in yields on medium tenor quality corporate bonds.
