【MACRO Insight】Is Germany's "whatever it takes" fiscal policy shift the prelude to a new chapter in

European markets reached a milestone after Chancellor-designate Friedrich Merz declared Germany would defend itself "at all costs" and pledged to ease restrictions on government spending, a decision that shook European markets on Wednesday and pushed European stocks outperformed U.S. stocks . German borrowing costs rose by the most in decades on Wednesday as investors bet that the historic agreements would provide funding for military and infrastructure investments, significantly boosting Germany's flagging economy. The 10-year German government bond yield surged 0.31 percentage points to 2.79%, the biggest one-day increase since 1990.

Germany is also calling on the EU to reform its fiscal rules, and Europe's largest economy wants the bloc to allow countries to increase defense spending without violating the bloc's budget rules given the geopolitical environment, according to people familiar with the talks. EU leaders are expected to discuss possible changes to fiscal rules at a meeting on Thursday, with European Commission President Ursula von der Leyen already suggesting a 150 billion euro EU loan to boost defense spending and loosen fiscal rules that limit state spending.

23 election and could block any constitutional changes in the next legislative period. The deal between Merz's CDU/CSU group and the SPD still needs the support of the Greens to reach the two-thirds majority needed to change the constitution, and while the Greens have long called for reforms to the so-called "debt brake," senior party figures have said they first need to digest the details of the plan, though analysts expect the party to eventually acquiesce.

Germany's "historic shift" is seen by many investment banks as a turning point for Germany and the entire European market. Its new strategy will release hundreds of billions of euros for transportation, energy and housing, subverting Germany's control over government borrowing and reminiscent of former European Central Bank President Mario Draghi's 2012 speech to save the euro at all costs. Economists at Deutsche Bank described the agreement as "one of the most historic paradigm shifts in Germany's post-war history," adding that "the speed of this shift and the scale of future fiscal expansion are reminiscent of the period of German reunification."

European stocks are among the best performers this year as investors bet on stimulus and a possible ceasefire in Ukraine, while Europes lower valuations have attracted funds to exit expensive U.S. stocks, temporarily overshadowing concerns about a global trade war. On a quarterly basis, the benchmark Stoxx 600 index is set to outperform the S&P 500, the most in a decade. Eight of the top 10 best-performing stocks in the MSCI World Index this year are European, including defense companies such as Rheinmetall, Thales SA, Leonardo SpA and Saab AB, according to data compiled by Bloomberg.

Additional fiscal spending may mean less need for monetary policy stimulus, and traders have reduced bets on an ECB rate cut by the end of the year to about 67 basis points from as high as 90 basis points at the beginning of this week . In terms of exchange rates, the euro's recent sharp rise has vindicated a few strategists who had opposed the argument that the euro would fall to parity with the dollar. Morgan Stanley, Credit Agricole and Commerzbank are among the investment banks that have defended the euro's prospects, and now the euro has risen 4% against the dollar this week alone to 1.08, compared with nearly 1.01 a month ago.

Germany's fiscal policy shift and a positive outlook for the European economy have significantly boosted the euro. Hedge funds are now betting that the euro could hit 1.20 against the dollar in six months, while some investors had previously expected the currency pair to fall below 0.95. Investment banks including Goldman Sachs Group Inc. and Mitsubishi UFJ Financial Group Inc.

The European Central Bank's sixth rate cut since June last year has brought market expectations of easing, which has formed a certain hedge with the shift in Germany's fiscal policy. Although ECB policymakers claim that the restrictiveness of monetary policy has been significantly reduced, the market's comprehensive consideration of Europe's economic fiscal and monetary policies is re-adjusting its judgment on future interest rate trends and economic conditions. Credit Agricole believes that the euro still has room for further appreciation in the coming months, arguing that huge defense spending may boost economic growth in the eurozone, and the potential end of the Russia-Ukraine conflict may lead to a drop in global energy prices, further helping the eurozone's economic recovery.