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German election: In Merkel we trust

On September 24th, Germany voted in a federal election to elect the members of the 19th Bundestag, Germany's federal legislative body. German Chancellor Angela Merkel has won a fourth term, but now faces drawn-out coalition negotiations and a splintered parliament.

Highlights

    • Merkel wins a fourth term, but faces tricky coalition talks after mainstream parties posted their worst results since the 1940s.
    • We expect the outcome to have limited impact on financial markets but see it slowing momentum behind Franco-German efforts to promote deeper eurozone integration.
    • The powerful position of German finance minister could be key in coalition talks and the future of the eurozone.

    Overview

    We believe the outcome of the German election will have limited impact on financial markets but see it slowing momentum behind efforts to strengthen the eurozone. The election result also showed euroskeptic sentiments still run high in the bloc, as evidenced by the larger-than-expected 13% share for the right-wing Alternative for Germany party.

    Merkel now faces drawn-out coalition negotiations and a splintered parliament, likely slowing down a Franco-German drive to promote deeper eurozone integration.

    We prefer European equities over eurozone 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 some scope for the U.S. dollar to regain some lost ground against the euro as the Federal Reserve presses ahead of policy normalization and inflation looks ripe for a potential rebound. We believe core inflation in the eurozone is likely to stay muted, keeping the European Central Bank accommodative.

    Market update

    Investors have not been pricing in a major risk event around the German election. Comparing the curve of the VSTOXX® index – the European equivalent of the VIX index, a common measure of equity volatility in the U.S. – ahead of the French and German elections this year shows investors anticipating volatility around the former, but a ‘normal’ curve with no equivalent price spike around the time of the latter.

    Coup concerns versus putsch placidity

    VSTOXX® term structure ahead of French and German elections

    VSTOXX term structure ahead of French and German elections

    Source: Bloomberg as of September 14, 2017