Change can be good: what markets expect from German elections

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(Bloomberg) – There was a time when markets worried that Angela Merkel – a beacon of stability in a turbulent world – would step down as Europe’s largest economy. That time is over.

As German voters go to the polls, investors are ready to accept the change and a possible left turn, provided it is moderate.

An increase in support for the Social Democrats and the Greens has raised expectations in the market that the next coalition will be less committed to the draconian enforcement of budget restriction rules that were the hallmark of Merkel’s conservative government before the pandemic. A good performance by the two center-left parties could also mean that post-Merkel Germany will be more enthusiastic in its support for the pursuit of European unification, another welcome development for the markets.

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“My money is on a significant increase in German public investment in the coming years, perhaps close to 1% of GDP, although – most likely – this will come via somewhat opaque fiscal engineering”, Erik F. Nielsen , chief economist at UniCredit SpA, wrote in a note. “The next German government will, on the whole, be more committed to Europe and further integration than in the past, mainly due to the likely substantial increase in the influence of the Green Party.”

While negotiations to form a new coalition can last weeks or months, here’s our guide on how investors might position themselves for the day after the vote:

Impact of actions

Large swathes of German businesses could benefit from the changing of the guard at the Chancellery, although polluting industries may have an account of the country’s accelerated transition to climate neutrality. An emerging consensus among all major political parties on the need for additional investment, especially in low-carbon infrastructure, could even have spillover effects on the continent’s stock markets more broadly.

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“In most scenarios, the focus on climate change is likely to increase, which could allow the utilities sector to recover some of the very poor performance since the start of the year,” wrote the strategists of JPMorgan Chase & Co. led by Mislav Matejka in a note. . “On the other hand, the biggest emitters of CO2, such as airlines, transport, steel, construction, could face headwinds.”

Analysts from UBS Group AG, including Felix Huefner, have identified Siemens Gamesa, Vestas, Infineon, RWE and E.ON among the companies that could benefit from a new coalition’s focus on further investments in green technologies and digital. A left or center-left government led by SPD Social Democrats could push for tighter labor market regulations and higher wages, which could hurt clothing companies like H&M and Zalando SE, as well as airlines and airports, including Fraport AG and Deutsche Lufthansa AG, which is also exposed to stricter weather rules, UBS said in a presentation.

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“We believe German assets could provide attractive investment opportunities for global investors, primarily in the equity market, with a focus on sectors moving towards the net zero goal by 2045,” wrote Thomas Kruse and Tristan Perrier from Amundi Asset Management in a note. “More generally, sectors such as green energy and automobiles could be attractive, given the emphasis placed on the transition to electric mobility. “

Currency impact

The likelihood of Social Democrat Olaf Scholz becoming the next German Chancellor is still not fully reflected by markets, according to Jordan Rochester, G-10 currency strategist at Nomura International Plc. Confirmation of a center-left coalition could prompt the euro to rise by around 1%, he said.

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Analysts generally view such a coalition as positive for the euro in the longer term as it would mean an increased likelihood of supportive fiscal policies. Rochester de Nomura sees the euro strengthen to $ 1.22 by the end of the year. The latest poll shows that Scholz’s SPD has a narrow lead over the center-right CDU / CSU bloc.

It is also possible that the euro will fall if the results remain unclear.

“Markets are perhaps a little complacent about the prospect of a long period of political uncertainty in Germany after the vote,” said Valentin Marinov, head of G-10 currency strategy at Crédit Agricole CIB. The euro could approach year-round lows against the dollar and the yen in that case, he said, pointing to the outcome of the last federal election. “The main driver of the euro’s weakness in 2017 was the lingering uncertainty in the aftermath of the vote.”

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A surprise shift to the center-right in any coalition could also mean that the euro “would be even lower against the dollar,” Marinov said, given market concerns about the growth prospects that are shattering. follow.

Still, the German election is unlikely to be the deciding factor in whether the euro breaks its current trading range, according to Kit Juckes, chief forex strategist at Societe Generale SA in London. Barring a big surprise, “it is much more likely to be concerns about rising rates due to inflation and more generally global risk aversion from China,” he said. he declares.

Bond markets

Bond investors are looking beyond the election, as global risk sentiment and expectations surrounding European Central Bank asset purchases continue to dominate the agenda.

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Optimism in Rome is also more important than German policy, with Italian bonds catching up with their more secure German counterparts. The yield spread narrowed Thursday to the lowest since April following news that Italy’s Treasury would ignore some regular debt sales given the improving economic outlook for the country. Ten-year Bund yields, meanwhile, have risen around 30 basis points since early August.

That’s not to say there won’t be drama. If the Social Democrats and Greens together get enough votes for a parliamentary majority, then Bund yields could rise by three or four basis points on Monday, while if the Left gets less than the 5% threshold required to elect the lawmakers at the next assembly, then German yields could drop as much as two basis points, said Rohan Khanna, a strategist at UBS.

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A coalition comprising the SDP and the Greens would be seen as more committed to further integration into the European Union, which would benefit Italian debt, according to Althea Spinozzi, rate strategist at Saxo Bank A / S. This result would push yields higher and help tighten their spread further against their German counterparts, potentially up to 75 basis points by the end of the year, the tightest in more than a decade, a- she declared. This forecast also takes into account Italy’s continued political stability and improving fundamentals.

However, these results are far from certain.

“If the results are as currently suggested by opinion polls, then many different coalitions are possible – so there should be no immediate reaction,” Khanna said. “In the medium term, ECB policy matters much more to Bunds than to local policy. “

© 2021 Bloomberg LP

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