Odd Lots - We Just Saw Europe's Biggest Week in Decades

Episode Date: March 7, 2025

This week was a busy one and some of the most interesting things that happened came out of Europe, where policymakers announced up to €800 billion of additional defense spending and an easing of Germany's stringent debt rules. All of this comes as Europe responds to tariff threats from the Trump administration, as well as worries that the Trans-Atlantic security alliance may be over. So how significant could these changes be? And what do they mean for things like the euro, the dollar, and the wider financial system? And what are the vibes in Germany like right now? On this episode, we speak with George Saravelos, head of currency research at Deutsche Bank, about this huge moment.Read more:EU Backs German Push to Look at Easing Fiscal Rules for DefenseTrump Hails Tariffs as US Economy Barrels Into Trade Wars Odd Lots is coming to Washington, DC! Get your tickets for our Jones Act debate here.See omnystudio.com/listener for privacy information.

Hey, Odd Lots, listeners. We're coming to D.C. We're finally doing it, Joe. It's going to be our first live show in Washington, D.C., our nation's capital. It's also finally going to be the time where we actually talk about the Jones Act. We've been talking about doing the Jones Act episode of Odd Lots for a long time, and it's become this recurring joke that we've never done on. But we're going to do it in grand style because we're going to be doing it live in D.C. And it's actually going to be a debate. Yeah. So we have Sarah.

Fuentes from the Transportation Institute. She's going to be taking the pro side. And we also have Colin Graebow of the Cato Institute. He'll be taking the against side. It's going to be really interesting to see how all of that shakes out. In addition to that, we're going to be speaking with Blair Levin, who was around during the telecom bubble. And we have Andrew Ferguson, the new head of the FTC, the one who's replaced Lena Con. We're going to be talking about mergers and acquisitions and all that stuff. So it should be a really fun night. want to come and join us for that evening. It's going to be on March 12th at the Miracle Theater. Go to Bloomberg.com forward slash oddlots and you can find the link to purchase tickets. We hope to see

you there. Bloomberg Audio Studios Podcasts Radio News. Hello and welcome to another episode of the Oddlots podcast. I'm Tracy Alloway. And I'm Joe Wisenthal. Joe, do me a favor and pull up a chart of the 10-year German Bund. Oh, yeah. Okay. Let's see. German generic 10-year bond. You don't know the ticker? You haven't memorized it? No. But we have the beautiful auto-fit.

Wow, that is a chart. So, you know, back in the beginning of December, the yield was about 2%. It's been climbing. It was about 2.4% at the end of February. And in the last two days, it's rocketed up. It's close to 2.9%. And I saw a headline yesterday. We're recording this March 6th.

The yesterday's move was the last. largest one-day move since basically around the time the Berlin well. Yeah. It's a line that goes straight up. Yes. It's a pretty big move, as you mentioned. The euro is also up against the dollar. Yeah.

European defense stocks have been soaring. There are lots of lines going straight up charts out there relating to Europe. European financials doing really well, too. It's like, you know, everyone was so down on everything in Europe. And then Trump was expected to make those lines go down further. and they've just been rocketing up. Yeah, and the argument that seems to be happening here is the idea that the possibility of tariffs from the Trump administration and the loss of the U.S. security umbrella are so bad for Europe that they could turn out to be good in the sense that Europe has to spend lots of money to counteract them. Maybe they integrate some more and maybe that'll boost growth.

And if you think about all the military equipment that they'll need to buy or maybe the possibility that long-suffering. German car makers are going to pivot into defense or something like that. It kind of makes sense. While I'm going to say what I'm about to say, you just pull up a chart of the Dax. Oh, yeah. It's pretty remarkable. Another line going straight up chart. You know, there's two elements here.

I mean, I joked yesterday that the history of finance Twitter is essentially 15 years of waiting for Germany to pull out the fiscal bazooka to sort of pull back from its obsession with balanced budgets, the Schwarznoll, did I say that okay? Schwartznoll? Schwarznoll? Yeah. So there's two things, though. There's one, there's the realization that perhaps more money should be spent.

And then two, there's can you get the political stars to align to act on that realization? And one thing people seem to be thinking is, and this is a very complicated problem for all kinds of structural reasons within the EU or the Eurozone. And there seems to be a belief and more than a belief that the sort of actions of the Trump administration over the last several weeks may be solving both of these problems at once. Right, in the sense that maybe you need a common enemy to galvanize some action. And I will just say specifically what we've seen this week. So we saw talk of a 500 billion euro infrastructure fund. We saw Germany saying that defense above 1% of GDP could be exempt from the debt break. This is the famous Schulden Bremse. And they also said German states can now borrow up to 0.35% of GDP.

That is up from zero. So a change there. And so I guess in conclusion there is a lot going on in Europe. And we should definitely talk about it. And I do in fact have the perfect guest for you. It's someone who I used to talk to all the time about European developments, specifically when we had the Euro crisis back in sort of 2011 to 2013. We're going to be speaking with George Seravelos. He's the head of FX research at Deutsche Bank.

George, thank you so much for coming on the show. Thank you very much for having me. It's a great pleasure. All right. So I've seen a few people call this a watershed moment. I've seen people call it whatever it takes 2.0. Barclays is calling it whatever it costs. Ralph Proiser over at Bank of America is calling it a paradigm shift in the sense that Europe is no longer funding the U.S. fiscal expansion. Instead, it's funding its own. And you yourself have called it history in the making. Walk us through how significant this is and why.

Sure. I would tend to agree with all of these characterizations. I would say it's not just the size and I can help walk through the size and provide some context, but also, the speed that is remarkable. You have to remember just a few weeks ago we're having the German election, the centrist parties lost the two-thirds majorities, and the centrist parties as well, especially the leading centrist party, the CDU, was not campaigning on any sort of fiscal expansion compared to what we're seeing now. So I'd say it's both the size and the speed that's taken markets by surprise. But just to go back to the size, and you went through the changes, infrastructure, we think, will be at least one, a bit more than 1% of GDP a year. The state level easing the reform to the debt break, that's another 0.35.

There's gaps that are being freed up on defense because now anything above 1% of GDP can be excluded, but Germany's already spending one and a half. So you have a half a percentage gap that's released immediately. and then any extra defence you want to do on top. And we think Germany would potentially target between 3 to 3.5% of GDP defense spending. If you add all of these things up, we're talking about a swing in the deficit of somewhere between 3 to 3.5%. Now, to contextualize that, the current German deficit is 2.5. So if you add that on top, we're somewhere between five and a half and six percent fiscal deficit.

Now, that is extremely high. It's approaching US levels and we know how wide the US deficit is. We know how the US feels about its deficit as well. Exactly. And critically, I would say this is not a one-off in the sense that the COVID support was a one-off. we are talking about a sustained increase in deficits of this order for multiple years, at least three, four, five, but for context, the infrastructure fund is a 10-year fund. The closest proxy, I think, is German reunification.

But even if you go back then and you look at the numbers, these are actually even bigger. Wow. So if you try and contextualize it, there were two big rounds of fiscal easing during the German reunification. The first one was 1990, and that was a de facto helicopter drop of money into Eastern Germany. That was when the Eastern Deutsche Mark and the Western Deutsche Mark were equated one for one. It was effectively a fiscal transfer to Eastern Germany. We calculate that to be 8% of GDP, so that was 1990. And then in 1995, you had another fiscal expansion, a one-off fiscal expansion, of roughly another 8%.

Now, we're talking here 6%. deficits, but for many more years. So if you add up the numbers, arguably this is even bigger than German reunification. You put out a note on March 4th, and it's filled with, you know, dramatic language. You say it's hard to overestimate the scale of change taking place in global economic and geopolitical relations. You say that this is the biggest shift in trade relations since the collapse of Bretton Woods. And I think it's very interesting that you mentioned even just a few weeks ago when Germany was having its national election. There wasn't much talk about this. What specifically from the Trump administration, whether it's on trade or defense, has caused such

a dramatic about phase? So I would say it's been building. It's been building for months. It's been building for weeks. But the watershed moment was really the Munich Security Conference. And we are Deutsche Bank. We're based in Germany. We get the vibe, so to speak. Yeah. But the political vibes domestically in Germany dramatically shifted after the Munich

Security Conference, the speech that was given by the Vice President, the broader body language around that. I'd be reluctant to say that was the single thing that caused everything, but most certainly it was a trigger. for a change in mindset. And this change in mindset, we identified as soon as the election was over in terms of the negotiations beginning. It culminated this week with the announcements. Say the announcements, even we were expecting something, but even for us, it was at the very top end of expectations. Can you talk about the corporate vibes, maybe? Are companies, our management

getting excited about extra fiscal stimulus, or are they still very nervous about both the security situation and the potential incoming tariffs? So the geopolitical backdrop has been a challenge. Trade uncertainty is clearly huge. And we saw it with the ECB meeting earlier today. But what I would say is this has been present in the background now for months. And you can see it in policy uncertainty indices in Germany and in broader Europe, which have been very high for a long time over the last couple of quarters.

So in a sense, what is really genuinely new over the last few weeks is this positive shock. And I think what is most interesting is, to give you an example, we had a large investor roundtable just last week in Germany. This is after the negotiations had begun. And around that roundtable, we had a large number of real money investors domestically based in Germany, allocating their money to European fixed income. And while everyone expected announcements around defence, no one really expected anything big on infrastructure. No one expected the reform of the debt break up front. So I would say this is just a bigger surprise internationally, as it is domestically,

at least from the investor feedback and the corporate feedback I've experienced. We've seen this big spike in the euro over the last couple of days. But, you know, it's still fairly low and it's not even back to where it was in the beginning of December. It's actually, it's still below pre-election levels. Could this dramatically change the trajectory over the coming months and years of the exchange rate? So I think to answer that question, you have to look at both sides of the Atlantic. Yeah. So you have to question what is going on with the US administration, what's happening in Europe. A very good starting point is to think about relative neutral rates or what's known as relative R-star. Now, in kind of high frequency,

short-term, on a short-term basis, of course, these things are very hard to estimate. But if you take a step back, relative neutral has been a pretty good guide in the broader dollar trends over the last few decades. Now, what's interesting is, and I use this reunification analogy, If you go back to them, that period saw the relative R-Star between Europe and the US go from around minus 200 during the mid-1980s to zero in the early 1990s. This was a period where the European neutral rate was rising, as Eastern Germany was being unified with Western Germany. You had the big increase in fiscal expenditure. So to answer your question, if this big infrastructure shift, the front shift goes ahead, if it's able to push trend growth higher, productivity higher, by extension, ECB rates higher,

I think it certainly has potential to be materially positive for the euro. Now, how positive also depends on what's going on the other side of the Atlantic and what are the policies pursued there. So maybe that's something to discuss in our conversation. But I would say how much trend growth is being affected and the ECBs is at the core of how much this can affect the Europe. Okay, I'm going to take the bait and ask the really simple question, which is what happens to a country's currency when they enact tariffs? So the U.S. And the reason I ask it is because people seem to have different opinions. On the one hand, some people think it slows down growth and therefore currency will come down.

Other people think maybe it'll speed it up. currency goes up, real rates go up, et cetera. Where do you sit in that debate? So it sounds like a very simple question, but I think as we've seen, it ends up being an extremely complicated one. I would say it depends on two things. How are the tariffs being enacted and to whom are the tariffs being enacted? Now, if you're talking about a situation of bilateral tariffs, so for example, under the first Trump administration, where it's just against China, the US clearly has an advantage. It's running a trade deficit. So by extension, if it applies a tariff, that tariff is going to be more damaging to the country it's running a deficit with because it's just a larger

portion of that country's goods. Now, I think when we're thinking about Trump policy under the second administration, we're applying the same logic. The US has a trade deficit, with the rest of the world. But there are two key differences, and this has also taken me by surprise compared to the start of the year. The first one is our tariff policies being applied. And I think the danger it's presenting to the US economy is it's being done in a very haphazard, inconsistent way where the market and businesses are struggling to understand both the path and the endpoint. And I mentioned that because if you look at the key transmission channel of tariffs into the economy, it's uncertainty. That was certainly the case during the first administration, certainly the case now.

And the pattern we're seeing ever since January is U.S. uncertainty is now going up faster than it is in the rest of the world. Now, partly that's because the rest of the world's already been worried about tariffs for a long time. But I think it's also the way the policy is being executed, that there is. is very little clarity and there is a constant back and forth. So I'll say that's the first. Yeah. I was just going to say even since we've been talking on this, we just saw a headline. Trump likely to defer tariffs on goods and services under USMCA, I guess by a month.

It's unclear. And this is from Howard Lutnik speaking on CNBC. So there are changes afoot even to the sort of North American trade relationship. It's changing by the day, the exact nature of this. Anyway, keep going. I think that's exactly it. It's the constant back and forth, which at the end of the day, makes it extremely difficult to plan. And remember, the starting point of expectation was a very positive one, that this would be a very business-friendly administration. So I'd say that's one part.

The second part relates to who you are tariffing. And if you are tariffing a country where the bilateral trade relationship is extremely strong, is less imbalanced, is more codependent, And here I'm referencing Mexico, but even more importantly, Canada. If you're tariff in such a country, the economic impact is going to be much bigger than if you're applying the same thing to Europe or China. Effectively, I think of the economy in the US as part of a broader North American economy. You have integrated supply chains that have been building for decades. And therefore, a tariff policy which essentially unwinds that and unwinds, an international agreement which you've signed, I think it's much more damaging than if we were

thinking about the same for Europe and China. So it's taken me by surprise that the whole policy started with Canada and is taking place in such a haphazard way. And I think that's at the core of why the dollar is not strengthened. So one of the things that I mentioned in the beginning is that in order to get to a point where Europe really pivots or reforms or in some way or it does something big. You really need two things to happen, which is you need the recognition that it should be done. And then you need the political stars to align. And that's very tricky within the Eurozone for various reasons, you know, setting aside German fiscal expansion, capital markets deepening, capital markets integration, other things like that,

progress on areas like that has been really slow, et cetera. You know, one of the things that we've seen, very interestingly enough, is that Donald Trump breathed new life into the liberal party in Canada. They were basically left for dead about a month ago, the party of Trudeau, who's not in the running to be the next prime minister, and now suddenly their polls are surging. Like when you look at the European political landscape, do the sort of center-right or center liberal parties, do they seem to have new signs of life in this environment? I think it's too early to tell because a lot of the major interventions in Europe have only happened over the last few weeks and in reference to the Munich Security Conference in particular. But what I would certainly agree with you is that the threatened withdrawal of the security guarantee is providing, if I could call it a guiding start to Europe in terms of something everyone can coordinate around with, which is defence.

And the one point to make is, of course, when you start Europe has a very low industrial defense base, it will need to build that out. But that's precisely the reason why that could serve as a new growth engine. And we have to think about broader spillovers of defence. For example, just over the last two days, we've seen negotiations between Italy and Turkey to develop drone technology. We're seeing a potential shift away from Starlink to European satellites. company for Ukraine. And all these things, the initial trigger might be a military reason, but there's broader technological spillovers and both spillovers. And the last point is, we have to remember the starting point of Germany is so low. Germany has not grown for the last

two or three years. Germany has engineering expertise, it has access capacity. The economy is actually fairly well placed to benefit from using defense as a new industrial strategy, so to speak. Germany is a third of Europe. So if Germany's moving, even if no one else is moving, it can be quite material, especially given that Germany has been the drag in the first place. And Tracy, you know, something that George mentioned, defense as a potential true engine of growth with spillovers.

I mean, this is the story, right, that we've been talking about in American industrial policy history. It really is always defense. And then defense gave us eventually the iPhone. But this really always seems to be how it happens, anxiety about existential security. I look forward to the German iPhone. Okay, I'm going to ask a sort of bigger question, just going back to the scope and the significance of all of this.

I have to ask what happens to U.S. treasuries here and the U.S. dollar in the sense that, you know, I mentioned earlier that one way of looking at this is that Europe is no longer funding the U.S. fiscal expansion. Instead, they're funding their own. Germany has, in fact, been a really important buyer of U.S. Treasuries in recent years. And Europe's also a big buyer of U.S. corporate bonds and, you know, U.S. Treasury purchases kind of go hand in hand with the dollar's special status in the financial system as the reserve currency. Does this change that equation, perhaps? Is the dollar at risk of losing its special status? Well, I think you raised. is a very important question, and there's different ways of looking at it. But my starting point

would be that you're absolutely correct in Europe being the marginal buyer of treasuries. There's been a lot of discussion recently around the Mara Lago Accord and the role of reserve managers. Central banks have not been buyers of US debt for the last 10 years. In fact, the share of reserves has been declining in terms of global GDP. So the marginal buyer has been, the private sector, it's been primarily Europeans, potentially Japanese, as you alluded to. Does that create a problem for the US? I would say it depends on what's going on with the US policy stance. If the idea is the US fiscal stance is shrinking at the same time because the US is consolidating, it's going to be okay. If the US is sticking with these deficits of six, seven percent,

And I think critically, when we're thinking about the funding of the so-called twin deficit, it's not just about the magnitude, but it's about the context. Is the US outperforming in terms of growth? Is the US respecting property rights, so to speak? Is the dollar a high yielder? If Europe is improving, but at the same time, all of these properties are highlighted are being undermined, for example, tariff policy slowing down US growth, it's causing the Fed to cut rates, the dollar is no longer a high yielder,

the Trump administration is making references to Greenland. At risk of slightly oversimplifying, that is a property ownership reference, which at the margin is eroding some of the attractiveness of the dollar as a safe haven. If all of these are happening at the same time, I would say it does put into question the dollar safe haven role. At the core of it, if I look at the US, the US needs to pursue sound economic problems.

policy and then it will be okay. If that doesn't happen, the threshold for the twin deficits to matter goes down. All right, George Saravallos from Deutsche Bank. Thank you so much for coming on Oblots. It was good to catch up with you after many, many years. Thanks so much. Yeah, that was fantastic, George. Truly the perfect guy. Thank you. It was a great pleasure. Joe, I'm so glad we did that episode because, as we pointed out in the beginning, there is a lot going on, certainly here in the U.S. The focus tends to be on what the Trump administration is doing. And there's been less focus, certainly, on the impacts in other countries. So it's good to catch up on all of that. And I think probably the most striking thing in all of this is the possibility of Europe really

coming together and integrating. Because if you think about the struggles the Eurozone had in the past, it was mostly around integration and political discord, even. up until, you know, a month or two ago, as George was saying, we had some political difficulties in Germany and the coalition government and things like that. It is very striking to see people coming together just a month later. Yeah. You know, there is a sense that I play devil's advocate for a second, that what is going on right now sounds very similar to what Jim Bianco told us a couple weeks ago about what a sort of de facto Mara Lago accord with, look like, which is Europe picking up a much larger share of the defense budget, the euro rising,

the dollar weakening, et cetera. I mean, that's what Trump browbeated European leaders about in the first administration, that they weren't living up to their NATO obligations and so forth. You know, so there's a sense that part of what we're seeing is something that Trump has wanted to see for a long time. But it's really striking to me the two things, sort of like this scale of whether it's North America or Europe, leaders not feeling that the U.S. is a reliable signatory to various agreements. And then also the fact that from a macro perspective, and I'd include China here too, we are seeing fiscal expansion in much of the world at the same time the U.S.

is kind of going into austerity mode, at least visibly like through Doge and so forth. And so that is a very, that's a notable macro shift. Well, you say that this is what Trump wants, but Trump also wants the dollar to maintain its special status, right? And in this scenario, again, going to the fiscal expansion idea, is Germany going to have enough money to finance both the U.S. and itself if it's pouring, you know, billions of euros into its defense sector and things like that? I doubt it. I think that balance is certainly shifting. Now, that doesn't mean that there aren't going to be any buyer. for U.S. Treasuries. We talked with Jim about the idea that, well, you know, the U.S. can always make its banks, for instance, buy more U.S. bonds. So there's that possibility. But I think this is something worth thinking about. Yeah. No, totally. I mean, look, I think that what I would say is we're in uncharted territory. And I just think about, like, all of the business leaders that I've heard over the years, she's like, oh, we just want certainty. We, you know, we're, we're, we're

We're okay with regulation. And it's usually something that they say during Democratic administrations. Like, oh, we just want certainty. We just want to know what the rules are going to be and so forth. And businesses love certain, all this stuff. And then really in the last few weeks, it feels like we've gotten the mother of all sort of uncertainty shocks as a result of all this. We got to figure out an uncertainty trade that's not just by the VIX. There should be a good one. Yeah. Or gold. There's got to be something.

Yeah, but gold's done really well. Yeah, that's true. All right. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

And I'm Joe Wisenthal. You can follow me at the stalwart. Follow our producers, Carmen Rodriguez, at Carmen Erman, Dashall Bennett at Dashbot and Kel Brooks at Kel Brooks. For more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have all of our episodes and a daily newsletter you can sign up. two. And if you want to chat about all of these topics, including FX, including defense, check out our Discord where listeners are chatting 24-7. There's always activity going on there,

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