Hey, Odd Loots listeners, We're coming to DC.
We're finally doing it, Joe. It's going to be our first live show in Washington, DC, our nation's capital. It's also finally going to be the time where we actually talk about the Jones Act.
Listen talk 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 DC 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 graybou 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 Lina Kong. We're going to be talking about mergers and acquisitions and all that stuff. So it should be a really fun night.
If you want to come and join us for that evening, it's going to be on March twelfth at the Miracle Theater. Go to Bloomberg dot com forward slash odd Lots and you can find the link to purchase tickets. We hope to see you there.
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Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway and I'm Joe wysent Thal. Joe, do me a favor and pull up a chart of the ten year German Bund.
Oh yeah, okay, let's see German generic ten year bond.
You don't know the ticker, you haven't memorized.
Oh, but we have the beautiful auto of it. Wow, that is a chart. So you know, back in the beginning of December, the yield was about two percent. It's been climbing. It was about two point four percent at end of February, and in the last two days it's rocketed up. It's close to two point nine percent. And I saw a headline yesterday. We're recording this March sixth. Yesterday's move was the largest one day move since basically around the time the Berlin will.
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. 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 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 US security umbrella, yeah, 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 interact 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 carmakers are going to pivot into defense or something like that, it kind of makes sense.
Well, I'm gonna say what I'm about to say. You just pull up a chart of the decks.
Oh yeah, it's pretty another line going straight up.
You know, there's two elements here. I mean, I joked yesterday that the history of finance Twitter is essentially fifteen years of waiting for Germany to pull out the fiscal bazooka, to sort of pull back from its obsession with balanced budgets. The Schwartz, the schwartznul. Did I say that, Okay, Schwartznul, Schwartz snul. 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 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 structure architectural 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 five hundred billion euro infrastructure fund. We saw Germany saying that defense above one percent of GDP could be exempt from the debt break. This is the famous schulden Blenza. And they also said German states can now borrow up to zero point three five percent of GDP,
that is up from zero. So 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 you all the time time about European developments, specifically when we had the euro crisis back in sort of twenty eleven to twenty thirteen. We're going to be speaking with George Sarah Valos.
Here'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 two point zero. Barclays is calling it whatever it costs. Ralph Preuser over at Bank of America is calling it a paradigm shift in the sense that Europe is no longer funding the US 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 part of 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 one percent of GDP a year the state level, easing the reform to the debt break that's another point three to five.
There's gaps that are being freed up on defense because now anything above one percent 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 defense you want to do on top, and we think Germany would potentially target between three to three and a half percent of GDP defense spending. If you add all of these things up, we're talking about a swing in the deficit of somewhere between three to
three and a half percent. Now, to contextualize that, the current German deficit is two and a half 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.
Oh, 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 ten 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 nineteen ninety and that was a de facto helicopter drop of money into Eastern Germany. That was when the Eastern deutsch Mark and the Western dotsche Mark were equated one for one. It was effectively a fiscal transfer to Eastern Germany. We calculate that to be eight percent of GDP. So that was nineteen ninety and then in nineteen ninety five you had another fiscal expansion, a
one off fiscal expansion of roughly another eight percent. Now we're talking here six percent 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 four, 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 Dutch back, 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 relocked in 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 our companies are 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 back around now for months, and you can see in policy uncertainty, in disease 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 round table 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 defense,
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 biggert surprise internationally, as it is domestically, at least from the investor fe 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. 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 are 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 re unification analogy, if you go back to them, that period saw the relative our star between Europe and the US go from around minus two hundred during the mid nineteen eighties to zero in the early nineteen nineties. 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 defense 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 Europe. Now how positive also depends on what's going on 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 it's going to affect the Europe.
Okay, I'm going to take debate and ask the really simple question, which is what happens to a country's currency when they enact tariffs so the US, 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's 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 the tariff's 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 deficits, so 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 good 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 how tariff policy is 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 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 US 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 tarifs for a long time, but I think it's also the way the policy is being executed that there is very little clarity and there
is a constant back and forth. I'd say that's the first.
Yeah, I'm just gonna say, even since we've been talking on this, Trump likely to defer tariffs on goods and services under us MCA. I guess by a month. It's unclear. And this is from Howard Lutnex speaking on CNBC. So there are changes of foot 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 tariffing 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 is 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 trick within the Eurozone for various reasons, you know, setting aside German physical expansion, capital markets, deepening capital markets, integration, other things like that, progress on areas like that has been really slow, etc.
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 poles 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 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 star to Europe in terms of something everyone can coordinate around with,
which is defense. And the one point to make is, of course, when you start Europe as 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 defense. 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 satellite company for Ukraine and all these things. The initial trigger might be a military reason, but there's broader technological spillovers and growth spillovers. And the last point is we have to remember the starting point of Germany is solo. Germany has not grown for the last two or three years. Germany has engineering expertise, 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 is really always seems to be how it happens. In 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 US treasuries here and the US 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 US fiscal expansion.
Instead they're funding their own. Germany has in fact been a really important buyer of US treasuries in recent years, and Europe's also a big buyer of US corporate bonds, and you know, US treasury purchases kind of go hand in hand with the dollars 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 raise 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 of not being buyers of debt for the last ten 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 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 at being undermined. For example, tariff policy slowing down US growth. It's causing the Fed to cut rates. The dollars 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 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, Sarahvelos from Deutsche Bank, thank you so much for coming on all lots. It was good to catch up with you after many, many years. Thanks so much.
Yeah, that was fantastic, George, truly the perfect game.
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 US. The focus tends to be on what the Trump administration is doing, and there's been less focused 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 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.
Yeah, you know, there is a sense that I played Devil's advocate for a second, that what is going on right now sounds very similar to what Jim Bianco told us a couple of weeks ago about what a sort of defactoed mar Lago accord would look like, which is Europe picking up a much larger share of the defense budget,
the euro arising, the dollar weakening, et cetera. I mean, that's what Trump browbeaded European leader is 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 in North America or Europe, leaders not feeling that the US
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 this same time the US is kind of going into austerity mode at least visibly, like throughout 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 US 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 buyers for US treasures. We talked with Jim about the idea that well, you know, the US can always make its banks, for instance, buy more US 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, it's like, oh, we just want certainty. We you know, we're okay with regulation, we just and it's usually something that they say during democratic administrations, like 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 vics. It should be a good one.
Yeah, yeah, but goal'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 All 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 Kerman Rodriguez at Kerman ermann dash Ol Bennett A. Dash By, and Kilbrooks at Keilbrooks. More Oddlots content, go to Bloomberg dot com slash odd Lots, where we have all of our episodes and a daily newsletter you can sign up to. And if you want to chat about all of these topics, including FX including defense, check out our discord where listeners are chatting twenty four to seven.
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