High stakes German election fuelling market uncertainty

September 7, 2021

Jeffrey Sacks

Head of EMEA Investment Strategy

SUMMARY

As Germany’s Angela Merkel, one of Europe’s longest-serving leaders, steps away from politics ahead of a pivotal election – her center-right party is behind in the opinion polls. We believe potential worst-case scenarios and months of political uncertainty could impact all asset classes.

The German federal election on September 26th could lead to the defeat of the CDU/CSU coalition that has governed the country for the past 16 years. The centre-left Social Democrats (SPD) are 5 points ahead in the latest polling.

Were the SPD to win, their eventual coalition partners would be very important in determining Germany’s policies. The current finance minister Olaf Schulz (SPD party) is the leading candidate for Chancellor, the position currently held by Angela Merkel who is stepping down from office after a long career in German politics.

The stakes are high, given the wide range of key issues: economic and health recovery from Covid; climate change; immigration; pressures for more fiscal expansion to ease ageing infrastructure pressures; possible tax increases to fund the fiscal expansion; Europe’s dependence on Russia for energy, on the US for defence, and on China for exports.

Rising Covid infections are raising concerns about more domestic lockdowns and more travel restrictions. Germany has done reasonably well in containing the Delta variant, however the level of vaccinations is one of the lowest in Western Europe (76% of adults have had at least one dose), and the pace of new first immunizations is slowing.

Uncertainly in the wake of a left-wing leaning governing coalition could hurt equities in the short-term through concerns about more regulation and higher corporate taxes, and higher outflows.

The sovereign bond market is expensive, with almost all German bunds across the maturity spectrum offering negative yields, and could be pressured by moves to ease the German ‘debt brake’ and expand fiscally.

Given the large range of possible outcomes, there could be a period of several weeks, perhaps even months, before the coalition is formalized, which could be reflected in euro weakness during that period.