Election Reaction

A Shrug of the Shoulders

119652064 Merkel DAX reaction
Angela Merkel doesn't move markets. That's a good thing. Picture source: Bloomberg

Germany’s election result wasn’t quite as boring as the campaign that preceded it. While Angela Merkel was handed a fourth term as chancellor, the right-wing Alternative for Germany garnered a larger share of the vote than expected. Added to that is the fact that Ms. Merkel now faces a horrendously complex challenge in putting together a three-way coalition government.

Don’t tell that to financial markets. The blue-chip DAX and EuroStoxx50 barely moved on the result Monday morning. The DAX even closed up 0.2 percent on the day, while the euro fell a little over 0.5 percent against the dollar in currency trading. It’s a far cry from the kinds of violent swings seen in the aftermath of Britain’s Brexit vote, Donald Trump’s US election and France’s presidential elections earlier this year.

In short, both investors and business groups seem confident that Germany and its powerhouse economy will continue trundling along just fine. The simple reason is that four more years of Angela Merkel promises continuity, and means markets will move on quickly from this election, said Tillmann Galler, a capital markets strategist for JP Morgan.

Yet these financial watchers are ignoring one very real possibility: Ms. Merkel’s Christian Democratic party could struggle to put together a stable coalition government. Given that Germany has until now been seen as a beacon of stability in a European sea of instability (think Italy, Greece, even France), that could have a major effect on markets in the longer term.

“Germany has become less predictable almost overnight, which should be a concern for markets.”

Elliot Hentov, State Street Global Advisors

As the dust settled from Sunday’s election result, many investors did seem to recognize the challenges Ms. Merkel faces, even if those concerns didn’t translate into major moves in stocks or currency trading. “Germany has become less predictable almost overnight, which should be a concern for markets,” said Elliot Hentov of US asset manager State Street Global Advisors.

Indeed Ms. Merkel will be trying something that’s never been tried before in Germany: A three-way governing coalition between her center-right Christian Democrats, the pro-business Free Democrats (FDP) and the more left-leaning Greens. The Greens and FDP in particular have major policy differences on European integration, refugees and the environment that will have to be reconciled. Most observers agree that talks over forming such a coalition could last until the end of the year or longer.

At best, this means Germany will be distracted for many months from making progress on other issues, like talks over Brexit or EU reform, according to Jan Gerhard, a senior analyst with IHS Markit. At worst, there’s an outside chance that coalition talks collapse altogether. If the Social Democrats stick to a pledge not to join any more governments, that could force new elections. Still, “the risk of a prolonged political stalemate severely disrupting foreign policy or the overall favorable business environment in Germany remains comparatively low,” Mr. Gerhard said.

Beyond that, there’s a risk that whatever coalition deal Ms. Merkel does manage to reach will not last the full four years, or that it will not reach the far-reaching policy consensus that allows Berlin to implement the kinds of major structural reforms that Germany sorely needs. Efforts to renew European integration could also stall, potentially putting some downward pressure on the high-flying euro in the coming months.

“The weak result could make Angela Merkel a lame duck much faster than international observers and financial markets think,” wrote Carsten Brzeski, chief economist of the Dutch bank ING-Diba.

That has consequences for Europe, which will be watching the coalition negotiations extremely closely, according to Uwe Burkert, chief economist of the state-owned Landesbank Baden-Württemberg. The FDP in particular has been opposed, for example, to French President Emanuel Macron’s push for further steps towards European integration. The election result, in that sense, could put the brakes on Europe, he added.

What does all this mean for financial markets? Björn Lesch, head of portfolio management at German asset manager Union Investment, suggests a cautious and deliberated approach to investing in Germany over the coming months. Even with the new political uncertainties, the economic outlook both nationally and internationally remains robust, while any political risk premiums are usually priced out again as the dust settles, he noted. In other words, “as the situation in Berlin becomes clearer, stocks in Frankfurt should start rising again,” Mr. Lesch said. After all, even with the current difficult hand dealt, German politics has long prided itself on boring stability over market-destroying chaos.

 

Christopher Cermak is an editor with Handelsblatt Global currently based in Washington DC. Leonard Kehnscherper is on an apprenticeship with Handelsblatt in Frankfurt. To contact the authors: cermak@handelsblatt.com

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