Euro-Dollar Rally Fades as German Negotiations Enter XXL Phase

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The stakes are high as multi-front negotiations inject a dose of caution into the Euro's relief rally.

Wide ranging negotiations on forming a new government get underway today, with the Green Party also yet to support plans to reform Germany's fiscal brake.

"The German debt-brake reform is not yet a done deal," says Wolfgang Münchau at Eurointelligence. "It was proposed by the prospective new coalition between CDU/CSU and SPD. They are well short of the two-thirds majority needed in both chambers of the German parliament, the Bundestag and the Bundesrat."

The CDU/CSU and SPD need the Greens to get the two-thirds majority required to enact constitutional change that would allow Germany to loosen the debt brake.

"EUR/USD’s stellar rally over the last couple of days ran into resistance recently," says Mathias van der Jeugt, an analyst at KBC Bank in Brussels. "We spotted a few drivers, including a special session in the outgoing German parliament today to discuss the €500bn infrastructure fund.. the political scene undermines some of the initial optimism."

Economists and investors see proposed spending plans as being a game changer for the German economic outlook as it would unleash the required spending to help Germany break free from stagnation.

Some estimates say the changes would allow the German government to invest as much as €1 trillion over the next decade. To put it into perspective, the country invested €1.5 trillion over two decades following the reunification of East and West Germany.

These expectations triggered an impressive rally by the Euro against the Dollar, Pound Sterling and majority of G10 peers. Uncertainty over whether or not politicians can negotiate the plan across the line will give the rally reason for pause.

"The EUR rally of the last two weeks has built heavily on this sea-change in Germany’s fiscal policy, but it still needs to be passed into law, and then implemented as actual spending," says Daragh Maher, Senior FX Strategist at HSBC.

Another junior partner, the FDP, has also yet to lend support.

"If this is the final word, it’s over. All the headlines about Germany’s bazooka would need to be erased," says Münchau.

The plans to boost spending are also still pending review at the Federal Constitutional Court in Karlsruhe.

Above: Coalition uncertainty gives the Euro-to-Dollar exchange rate reason to unwind overbought conditions (see RSI signalling overbought in lower panel.

However, German politics is notoriously good at reaching compromise, and Münchau points out that it is not in the DNA of the Greens to be blockers of progress.

This Thursday, the negotiating teams of the CDU/CSU and SPD will meet for the first time in what is dubbed "the XXL negotiations". 

256 delegates, divided into 16 working groups of 16 politicians each, are expected to put together the coalition agreement in the coming weeks.

"The working groups are requested to complete their work by 5 p.m. on Monday, March 24, 2025 at the latest," says an internal document governing the negotiations, seen by BILD.

The markets will welcome an agreement, but until then there is reason to for Euro bulls to exercise caution.