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By Jamie McGeever

ORLANDO, Florida, March 6 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

Another day of high drama in world markets on Thursday saw an interest rate decision and guidance from the European Central Bank, and a widening of this year's U.S.-Europe divergence as Wall Street sank and German stocks hit new highs.

The ECB cut rates as expected, and President Christine Lagarde said the bank will be "attentive and vigilant" to the changing landscape in the wake of Germany's plans to embark on its biggest spending spree since reunification.

Germany's DAX climbed to a new peak, German bond yields extended Wednesday's historic gains, and the euro held its gains as several banks raised their euro zone growth forecasts - a stark contrast to the deteriorating price action and economic backdrop on the other side of the Atlantic.

Figures showing historic U.S. layoffs and a record trade deficit set the early tone, and swirling uncertainty surrounding Washington's trade policy - despite President Donald Trump announcing temporary exemptions on some tariffs - ensured Wall Street's main three indices closed in the red.

Friday's focus is firmly on the U.S., namely January's jobs data and public remarks by Fed Chair Jerome Powell. Investor sentiment towards the U.S. economy and markets going into these two events is downbeat. The longer the gloom persists, the higher the bar is for lifting it.

Today's Key Market Moves

• Wall Street slides sharply, with the Nasdaq falling 2.6% to its lowest close in five months. It is now down 10% from its December high, putting it back into 'correction' territory.

• Germany's DAX tacks on 1.5% to print a new all-time high, and futures are pointing to a 0.5% rise at Friday's open.

• The performance gap between Germany's DAX and the Nasdaq this year is a remarkable 25 percentage points - the DAX is up 18% year-to-date and the Nasdaq is down 7%.

• Chinese tech stocks jump 5% to the highest since December, 2021, as investors pile into AI shares and welcome new policy support.

• Marvell Technology shares tumble 20%, their worst day in 24 years as in-line revenue forecasts fail to impress investors.

• Sweden's krona cements its place as the best-performing G10 currency, and is now up almost 10% vs the dollar this year.

Berlin's historic shift redraws euro rate horizon

Germany's plans to go on its biggest public spending spree in 35 years will likely lead to higher long-term borrowing costs across the euro zone – and that's a good thing.

While the European Central Bank may have proceeded with its widely flagged 25 basis point cut on Thursday, lowering the policy rate to 2.5%, the real story in Europe this week is the sudden and spectacular jump in euro bond yields and massive shift in expectations for the ECB's terminal rate.

Up until now, Europe's economy was widely viewed as stagnant and unproductive, reflected in the low yields on German bonds versus Treasuries, dovish expectations for the ECB's policy path, and estimates of an ultra-low or even negative long-term neutral interest rate.

But this all changed in an instant this week.

On Wednesday, news of Berlin's fiscal plans sent Germany's 10-year Bund yield rocketing the most since the euro was launched in 1999, and, by some estimates, since 1990.

Money markets are moving too. Implied pricing now suggests the ECB will not cut interest rates much more from here – a notable shift from market expectations only 48 hours ago.

While talk of 'European exceptionalism' may still be a stretch, the gap between the euro zone and the U.S. is narrowing on many fronts, including growth expectations, equity prices, and, now, interest rates.

This is a good reminder that while bond yields can rise for bad reasons – worries about widening deficits, burdensome debt loads, or plain old inflation – they can rise for good reasons, too.

For Germany this should be stronger growth, greater investment, increased productivity, and deeper fiscal coordination across the continent. It's a set of goals analysts have been urging the bloc to pursue for years. If the euro zone is successful in achieving them, it will need to get used to higher borrowing costs – but that's not a bad exchange.

POSITIVE R-STAR?

Policymakers are less nimble than market traders, so the ECB can be forgiven for cutting rates on Thursday, even as bond yields across the bloc were spiking.

The central bank noted that policy is becoming "meaningfully less restrictive," and President Christine Lagarde said policymakers must be "attentive and vigilant" to the new fiscal landscape.

This all suggests that the ECB's 'terminal rate' - the lowest point of the easing cycle still in play - will now be higher than previously thought. The question is how much higher.

Economists at Nomura have already removed two quarter-point rate cuts from their ECB outlook and are now forecasting a terminal rate of 2.25%. They had previously speculated that the ECB could go as low as 1.50%.

JP Morgan economists reckon a terminal rate below 2.00% is now unlikely, and that's where euro money markets appear to be settling as well. This all suggests the ECB is probably close to the end of its easing cycle, which chimes with a speech by ECB board member Isabel Schnabel, who argued even before this week's news that a "pause or halt" to rate cuts may be approaching.

Importantly, it's not just the outlook for nominal ECB rates that is changing. Estimates of "R-star" – the inflation-adjusted neutral rate of interest that neither slows nor accelerates economic activity – will likely rise also. And there's plenty scope for that.

Several leading models have long indicated that the euro zone's R-Star is ultra-low or even negative, meaning the region's economy requires a real interest rate below zero over the long run.

In light of this week's news, it's safe to say those models – and many investors' priors – will need to be updated.

What could move markets tomorrow?

• U.S. non-farm payrolls report (January)

• Fed Chair Jerome Powell speaks at University of Chicago Booth School of Business

• Fed's John Williams and Michelle Bowman speak

• ECB President Christine Lagarde speaks at event in Frankfurt

• Germany industrial orders (January)

If you have more time to read today, here are a few articles I recommend to help you make sense of what happened in markets today.

1. Kicking the tyres of 'perfect' Wall Street pricing

2. Trump policies cast chill on Wall Street dealmaking

3. 'Psychodrama' tariff negotiations frustrate Mexico and Canada

4. Lawyers must now be geopolitical analysts

5. Fed's Waller doesn't see need to cut rates this month

I'd love to hear from you, so please reach out to me with comments at jamie.mcgeever@thomsonreuters.com. You can also follow me at [@ReutersJamie and @reutersjamie.bsky.social.]

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

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(By Jamie McGeever; editing by Diane Craft)

((jamie.mcgeever@thomsonreuters.com; Reuters Messaging: jamie.mcgeever.reuters.com@reuters.net))