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What Next For Merkel? Wealth Managers React To German Elections

Tom Burroughes, Group Editor, September 26, 2017

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Although she has lost votes, the German chancellor is set to start a fourth term. Wealth managers speculate on the changing fortunes of the leader of Europe's largest economy.

Germany’s Angela Merkel has embarked on trying to assemble a new administration after her conservative (Christian Democrat Union/Christian Social Union) won 33 per cent of the vote, a drop of 8.5 points and the lowest level since 1949. In a much-commented development, the anti-immigration Alternative for Germany party picked up votes. The center-left Social Democrats fared poorly.

The result is being interpreted as a rebuke by voters to Merkel’s decision to allow in heavy numbers of immigrants from the Middle East amid the Syrian crisis. Even so, while the AfD party has picked up votes, it is not a decisive breakthrough for the far-right, in much the same way that the nationalist party of Marine Le Pen in France lost the French presidential elections earlier this year, and how anti-immigration parties in Holland failed to win power this year. There has been speculation that Europe will be roiled by the upsurge of nationalistic, anti-free trade parties, stimulated to some degree by the UK’s Brexit vote and the election last November by Donald Trump. An issue with that analysis is that while Brexit, for example, had a nationalistic tone for some, it was also in part driven by distaste for bureaucracy in Brussels and red tape.

Germany is the largest economy in Europe; its fortunes are central to the success or otherwise of the euro-zone. Besides immigration, Merkel has wrestled with how to deal with the crisis engulfing Greece amid the euro-zone crisis. She also has played a major part in framing how the EU reacts to the UK’s vote to get out of the EU.

With all that out of the way, here are some reactions by wealth and investment managers to the German poll and the outcome:

Jeff Taylor, head of European equities at Invesco Perpetual
Getting a coalition together is not going to be straightforward for Merkel, but in that she emphasized her desire for stability last night, she will clearly be trying for a majority coalition rather than a minority government. Coalition building will presumably take some time as politicians haggle over who gets what ministry, but this isn’t abnormal in Germany. Back in 2013, for example, they took three months.

 There are real differences in the policy priorities of the FDP [Free Democrats] and Greens and these two parties are not obvious bedfellows. However, they have come together with the CDU to form the regional government of the small state of Schleswig Holstein, so it’s not impossible. At national level, one might expect the FDP to be wary and want to be sure of extracting its pound of policy flesh in its negotiations with Merkel: its last involvement in a Merkel-led government was followed by a collapse in support which saw it booted out of the Bundestag…

For us, the priority is to assess whether anything has happened which will have major implications - and especially negative implications - for European markets. On balance, we think not.

We don’t see Merkel as holed beneath the waterline by this election: it would be inaccurate to draw an analogy with Theresa May’s experience after the UK election. She will have domestic issues to concentrate on in the coming weeks, but we are not convinced that she’s leaving the centre stage of European politics any time soon.

With the FDP in a coalition, Germany may end up cutting taxes by more than the CDU-CSU was proposing - that could well be positive for European growth at the margin. Could the future position of finance minister Schäuble come in question if the FDP insist on that post? Possibly, but that wouldn’t have to imply a move in an anti-business direction. An FDP influence on the coalition may dampen Germany’s willingness to move ahead any time soon with European budget integration, as the FDP are pro-European but not in favour of European transfer union. That could lead to some widening of peripheral bond spreads, but a seismic breakdown of the cordial relations with France’s new, young, reformist, business-friendly President (whose government incidentally includes a number of German speakers) looks a bit farfetched.

UBS Chief Investment Officer Wealth Manager
While the Green party is broadly pro-European, the presence of the FDP in the coalition has the potential to dilute Merkel's desire for a close alliance with French President Emmanuel Macron to promote closer European integration. The FDP does not support fiscal aid for more indebted nations on Europe's periphery. As a result, it is possible that we could see a widening of the spread between German yields and those of Italy, Spain, Greece, and Portugal - though markets may await policy pronouncements from the new coalition before making such an adjustment. While it is possible that the euro could open lower, reflecting disappointment over the absence of a grand coalition, the presence of the FDP in government could lead to stronger German pressure for fiscal discipline in peripheral countries, a long-term positive for the currency.

The euro has already appreciated close to 14 per cent versus the US dollar so far this year. If the FDP joins a coalition, it could also seek to obstruct plans to turn the European Stability Mechanism, which provides financial assistance to troubled eurozone states, into a permanent monetary fund. Finally, the FDP may oppose deeper fiscal integration through the appointment of a euro-zone finance minister.

BlackRock Investment Institute
A big question is whether the head of Germany’s finance ministry might switch. Would Merkel’s offering this powerful position to the SPD bring the Social Democrats back to the negotiating table? Such an outcome could soften Germany’s stance toward peripheral euro-zone countries and cause an uptick in government spending.

The European Commission has already called for greater public investment to boost Germany’s potential growth and spur economic activity elsewhere. Franco-German cooperation had been seeing a revival with new French President Emmanuel Macron. Berlin flagged cautious openness to Macron’s push for a centralised euro-zone finance ministry and backed the idea of turning the crisis-fighting European Stability Mechanism into a European Monetary Fund to pool fiscal resources. Germany has ruled out the euro-zone’s issuing jointly guaranteed debt.

Germany’s splintered parliament could make Merkel more cautious is supporting pan-European initiatives. In addition, the euro-zone’s solid economic expansion could dull the appetite for major reforms. Italy’s election next spring is likely to result in a hung parliament, further limiting the scope for reforms.

We prefer European equities over government bonds and credit amid a sustained, above-trend economic expansion and a steady earnings outlook. Companies with much of their cost base overseas should have some cover against a strong euro in the short term, we believe. We see scope for the US dollar to regain some ground against the euro as the Fed presses ahead with policy normalization and US inflation looks ripe for a rebound. We believe core inflation in the euro-zone is likely to stay muted, keeping the European Central Bank accommodative.

 

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