Angela’s Charlies: your guide to how the Merkel succession could affect German policy, the direction of Europe, and markets

02 September 2021

Imogen Bachra, CFAEuropean Rates Desk Strategist

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4-minute read time

Key takeaways

  • Markets will mostly be concerned with where candidates and their parties lie on their attitudes towards Europe and European integration, fiscal policy – both domestically and in Europe.
  • Polls have shifted considerably in the last few weeks and Germany looks set for another coalition government, with the Greens likely to be kingmakers in most realistic scenarios.
  • For markets the scope for real surprise looks limited as most realistic coalitions will still be pro-EU and pro-fiscal policy, but to varying degrees – and market implications.

Whatever the outcome of Germany’s Federal Elections (26 September), it will mark the end of Angela Merkel’s 16-year Chancellorship. The potential political shake-up comes at a crucial point in the economic recovery – one heavily supported by very expansive fiscal policy. And with the future direction of fiscal policy (amongst other things) potentially swayed by the outcome, markets rightly view it as an important juncture for European politics.

Let’s take a closer look at who’s running, their fiscal stance, what we think the likeliest outcomes will be – and what all of that means for markets.

Who is in the running? Meet the candidates and their policies

We think markets will mostly be concerned with where candidates and their parties lie on their attitudes towards Europe and European integration, and fiscal policy (both domestically and at the EU-level). So we’ve summarised the main candidates and their party positions below, from left (Die Linke, or ‘The Left’) to right (AfD) of the political spectrum. As you can see, there’s considerable variety across parties on these (and other) areas.

Candidates at a glance: successors strike their policy pose

Sources: NatWest Markets, political party manifestos. NB: The ‘debt brake’  is a balanced budget amendment used by the German federal government, which imposes strict budget limits on federal states.

Polls imply a high degree of uncertainty – but Greens look likely to be kingmakers

Polls have shifted considerably in the last few weeks. Greens and CDU/CSU had until late August been clear front-runners (with an alliance of more than 50% looking likely) but are now losing ground to SPD. CDU/CSU still tops the list of voting intentions, having regained its lead over the Greens a few weeks ago, but only at 25%, down from highs of 36%.

Germany looks set for another coalition government, but the Greens will be hard to exclude on most projections. We expect that a CDU/CSU-SPD ‘grand coalition’ will be strongly resisted if alternatives are available. If the Greens turn out of to be the second or third largest party, as polls suggest they might, then they will likely be the kingmaker.

Our base case is for a “Black-Green” coalition formed of the CDU/CSU and Greens. This currently seems to be the only realistic two-way governing alliance, and at the time of writing polls give the Black-Green pairing a total of 44%, still short of an outright majority of 50% (although it’s likely less than 50% of votes would be required for a majority because of smaller parties dropping out due to thresholds to enter parliament).

But we also think a “Jamaica” coalition – composed of the CDU/CSU, Greens, and FDP, which is currently the most popular party combination in the polls – could happen if a CDU/CSU- Greens alliance needs a third party to get them over the line. The fiscally conservative FDP would be the most obvious choice, given CDU/CSU is unlikely to want to govern with the Left, has ruled out an alliance with AfD, and because SPD will likely want to position itself in the opposition rather than as junior partner to CDU/CSU again (though it’s worth mentioning that FDP pulled out of such an alliance during negotiations in 2017).

The probability of these and other potential election outcomes are summarised in the chart below.

Possibly maybe: current coalition vote shares and our probability estimate of their coming to power (in brackets)

Sources: NatWest Markets, Wikipedia, pollofpolls.eu. The x-axis reflects the percentage share of votes.

What does all of this mean for markets & investors?

For markets the scope for real surprise looks limited as most realistic coalitions will still be pro-EU and pro-fiscal policy, albeit to varying degrees. The Greens are likely to enter government as a substantial junior partner in most realistic scenarios. Their influence on fiscal policy and the European project should be taken positively by markets, and risk markets in particular. The AFD lacks momentum and is likely to remain marginal; their Eurosceptic rhetoric and fiscal stance means any meaningful participation within a coalition would pose a risk for markets, but it is highly unlikely that any other party would form a coalition that includes it. And finally, Germany has already shifted on fiscal spending. It has become a bigger spender at home and more accepting of fiscal ‘innovation’ in the Euro Area.

How might bond markets react? Markets will assume that coalitions led by the CDU or involving the FDP will focus on stricter fiscal discipline, both at home and the European level, which as the chart below suggests, is better for German government bonds (or bunds) but less so for those issued by more peripheral European countries (as evidenced by the spread between the yield on bunds and Italian government bonds, or BTPs). On the other hand, coalitions that include the SPD and Greens might imply the opposite. A CDU/Greens government would be market-neutral and remains our base case.

As it stands, polls suggest a higher degree of uncertainty in this election than previously, with the three biggest parties sharing an almost equal portion of the vote. If that comes to pass, negotiations could be lengthy. In 2017, for example, Merkel announced that she would invite the Greens and the FDP to preliminary coalition talks three weeks after polls closed, but a deal took 164 days to be agreed.

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