What do the German election results mean for markets?

The German elections have corroborated what much of the European establishment already suspected: that the country’s political compass had splintered greatly in the last few years.

For those not abreast of the latest, Merkel’s CDU/CSU — now fronted by Armin Laschet — narrowly lost out to the Social Democrats over the weekend. But the biggest takeaway of the vote has been the diminishing size of the collective centrist vote, with results that looked like this:

It is only now that the hard work of forging a three-party coalition begins. But while the fragmentation is unlikely to be news for eagle-eyed politics watchers, Helen Thomas, founder and CEO of analysis firm Blonde Money, has been warning for months that markets have been failing to account for the possibility of a greener and more-left leaning German political establishment from October onwards.

In that context, they may have also missed that with the Greens in the frame in most coalition scenarios, Germany’s longstanding commitment to “schuldenbremse” — aka its debt brake — may soon also come undone.

As she noted before the election:

There couldn’t be a clearer sign that the political centre has shifted. Germany is going to spend more, whatever the outcome of Sunday’s election.

Adding that:

The financial crisis unleashed a wave of anti-establishment tendencies in countries across the world. The system was no longer working for the 99%. But the arrival of a global emergency challenged that narrative. Who else can resolve a crisis of such a scale other than the State?

But it must do something with this new power. The rise of the Green Party in Germany shows that voters want a change to deal with the new challenges facing our society. The revolution is still on. But now it must come from the establishment rather than from outside forces rising up against it. Governing parties across the world have shown that they can think the unthinkable when the emergency demands it. Proponents for action on climate change have been banging this drum for decades. Now, they might finally get their opportunity.

It’s time for the Establishment to deliver the Revolution. A greater role for the State means more spending, more regulation, more reform. New governments must use this power wisely.

The point essentially being that whichever way you cut it, German reticence to spending big is likely to be nipped in the bud in the name of the energy transition.

This will inevitably have an impact on yields and the cost of money, she suggests.

Others aren’t so sure. Capital Economics’ Franziska Palmas disagreed in a note on Monday, saying:s

Regardless of which parties end up forming the government, fiscal policy in Germany seems likely to remain relatively conservative. Accordingly, we still expect that 10-year government bond yields there and in the rest of the euro-zone to rise by less than in the US as the economy continues to recover and for this to put downward pressure on the euro.

This view is based on an expectation that more limited fiscal support and a slower economic recovery in the euro-zone than in the US will cause inflation to fall back more sharply in the euro-zone next year. This also underpins our forecast that the ECB will raise interest rates later than most anticipate and much more slowly than the Fed.

But according to Thomas, clues that the centre is seeking to curry favour with the Greens with spending reconsiderations has been out there for a while (her emphasis):

The leader of the CDU’s sister party, the CSU, stood up in the Bavarian State Parliament on 21st July and set out his “Klima-Programm Bayern”1. Markus Söder deliberately invoked the words of Churchill2 as he demanded “Action this day” to deal with the climate crisis. He admitted it would cost money. A lot of money. (“By 2040, it will be almost 22bn Euros”). But this “shows how serious the state government is”. He went on to argue that it “must be embedded in serious and solid financing… sustainability is not only a question of ecology, but also of financial reliability. That is why we in Germany should generally consider how we can reconcile climate protection as a permanent task with the debt brake. Just suspending it is not a solution. That must be clarified in terms of constitutional law.”

In one fell swoop he shattered the myth of a centre-right slavish obsession with prudence. Black zero is no longer a red line. The debt brake, or “Schuldenbremse”, became part of the German constitution in the aftermath of the financial crisis in order to signal their resolve to restoring a balanced budget. But now a senior member of the centre-right governing party is suggesting that climate change is so important that the constitutional commitment needs to be tweaked.

How this plays out, we will see over the weeks to come, as the concessions made by the parties that get into the governing circle become ever clearer.

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