German Defense Stocks Surge Following Announcement of €500 Billion Special Defense Fund

German defense stocks have emerged as some of the top performers globally this year, a trend bolstered by the announcement from Friedrich Merz, the incoming Chancellor of Germany, regarding a €500 billion special defense fund. This substantial allocation is set to significantly enhance Germany’s military capabilities.

In addition to the fund, Merz revealed plans to reform the country’s debt brake, allowing for defense spending above 1% of GDP to be exempt from standard debt limits. This move is expected to provide much-needed flexibility in military funding.

In the bond market, German Bund yields rose by 2.7 basis points, reaching 2.50% after hitting a low of 2.43% earlier in the day.

The €500 billion fund represents a notable 12% of Germany’s GDP, underscoring the scale of this initiative.

Further details indicate that this fund will not only support defense but also infrastructure projects, suggesting a broader strategy that includes significant increases in military spending.

Goldman Sachs provided insight into the implications of this funding strategy. According to a recent Bundesbank proposal, the debt brake reform aims to prioritize investment spending within its framework. The proposal suggests a tiered deficit rule that allows for a structural deficit of 0.9% of GDP for incremental investment spending above a baseline investment ratio, applicable if Germany’s debt-to-GDP ratio remains above 60%. If the ratio falls below 60%, the structural deficit could increase to 1.4%, with additional provisions for unconstrained spending.

Overall, the Bundesbank estimates that this reform could create an increase in fiscal space amounting to €99 billion (2.3% of 2024 GDP, or 0.4% annually) by 2030 if the debt-to-GDP ratio stays above 60%. If the ratio declines below 60%, the fiscal space could expand to €222 billion (5.2% of 2024 GDP, or 0.9% annually), predominantly in the 2028 to 2030 timeframe.