March 06, 2025

Whatever It Takes

Market Commentary

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Chancellor-in-waiting Friedrich Merz declared that Germany is prepared to undertake "whatever it takes"—a phrase popularized by former European Central Bank President Mario Draghi—to safeguard the nation and to revise the constitution to exclude defense and security expenditures from fiscal spending constraints.

Germany's unprecedented expenditure initiatives are significantly impacting the region's financial markets, propelling European equities to outperform their U.S. counterparts this year and bolstering the euro from nearing parity with the U.S. dollar.

Yields on 10-year German bonds surged above 2.8%, marking the most significant increase since mid-2022. Despite this rise, Germany’s borrowing costs remain among the lowest in the region due to its historical constraints on public spending. Investors also sold off riskier debt across the region, leading to higher yields in Italy, France, and the United Kingdom—all of which have faced market concerns in recent years regarding excessive fiscal expenditures.

Germany 10 Year Bond Yield Chart

Germany's decision to scale back offshore investments amid a rising budget deficit, coupled with other major economies like China, Russia, and Japan reducing their holdings of US Treasuries, could lead to a significant spike in US bond yields.

Consequently, rising yields could elevate borrowing costs across the economy, impacting businesses, consumers, and government debt servicing, potentially slowing economic growth.

In our view, the US should prioritize reducing its borrowing yields to safeguard its economic stability, particularly in light of recent US ADP employment change data that fell short of market expectations. The job market, a critical indicator of economic health, has shown signs of deceleration, suggesting potential vulnerabilities in the broader economy.

US ADP Employment Change (in thousand)

When the Fed expanded its balance sheet significantly (especially around 2020-2021), yields dropped to historical lows. Conversely, as the balance sheet started shrinking (quantitative tightening), yields climbed.

This suggests that for the Fed to bring yields lower again, they may need to expand or at least stop shrinking their balance sheet. A larger balance sheet means more liquidity in the financial system, increasing demand for Treasuries and pushing yields down.

The Fed's Balance Sheet (white) vs. US 10 Year Treasury Yield

If U.S. Treasury yields drop, Indonesia's equity market could benefit from the capital flows to Emerging Markets. Lower U.S. yields reduce the appeal of U.S. assets, prompting investors to seek higher returns in emerging markets like Indonesia.

Therefore, we suggest investors to watch the Fed's balance sheet level and US Treasury yield as an indicator for foreign inflow outlook to Indonesia. Meanwhile, we expect possible outflow due to Germany's needs to scale back their offshore investment to cover their budget deficit.

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March 09, 2025

March 06, 2025

March 05, 2025