German elections: Was nun, Mutti?
- While Merkel was the unsurprising winner of yesterday’s elections, the outcome did suggest a shift in the German electoral landscape as the populist far-right AfD came in third
- The process of finding a workable coalition starts now, but we may not see a new government before Christmas
- There are two feasible coalitions: a renewal of the Grand Coalition with the SPD (386 out of 709 seats, preliminary) and the ‘Jamaica’-coalition with the FDP and the Greens (378 seats in total). SPD leader Schulz currently rules out any role in government for the Social Democrats on the back of the party’s weak results, so ‘Jamaica’ now seems the most likely option
- It would be the first time that a coalition of three parties governs Germany and they are ideologically very far apart. They can find consensus relatively easily on domestic- and fiscal policies, but on European issues it will be much harder
- The market impact is muted. The negotiations will be difficult, but political risk-related volatility is currently hardly priced in
A political earthquake, German style
While Merkel was the unsurprising winner of yesterday’s elections, the outcome did suggest a shift in the German electoral landscape as the populist far-right AfD came in third. It’ll be the first time since WW2 that a far-right party will enter the Bundestag. Their win came mostly at the cost of the CDU/CSU and SPD, who posted their worst combined results since 1948. The centre-right FDP is now back in parliament, while the left-wing Greens and Left stabilised. The process of finding a workable coalition starts now, but we may not see a new government before Christmas.
There was always little doubt that Angela Merkel and her CDU/CSU party would win the elections (see figure 1). The opinion polls in the run-up to the vote were pretty consistent and showed that her ‘Union’ had a sizable and most of all stable lead. In the end this materialised, though a bit less than expected. The brief surge in the polls that the social-democratic and pro-European SPD enjoyed after it chose Martin Schulz as its front-runner signalled that most Germans possibly would have liked to see a fresh face, but certainly not a radical change of Germany’s course. Yesterday’s results have largely confirmed this notion, though the rise of the AfD on her right flank will give Merkel cause for concern. Schulz described Merkel as an Ideen-Staubsauger who steals the SPD’s and the Greens’ thunder on a wide range of issues, but the AfD’s rise suggests this strategy now partly backfired.
The debates, the campaigns and the elections have been langweilig, but we expect that we can’t say the same about the coalition talks. Much is still open. Schulz has claimed in public that the SPD will go into opposition, so a ‘Jamaica’-coalition (CDU/CSU-FDP-Greens) seems more likely at this juncture. We initially expected to see a renewal of the Grand Coalition, but the Social Democrats may still reconsider their position in the future as the party debate about its (and Schulz’) future starts. In this short special, we’ll discuss the results of yesterday’s vote, how this has impacted financial markets and then speculate a bit about the two possible coalitions.
The results are still preliminary at this stage, but there’s no reason to expect any major shifts from what we know now. The CDU/CSU coalition came in first at roughly 33%, losing about 8.5 percentage points compared to 2013 (which was a stunning result!). The SPD clocked in at just over 20%, the worst result ever recorded. The AfD, a populist and far-right outfit, scored a surprising 13% and came in third. Their strong and surprising result should to a large extent be seen as a protest vote of the German population, not as an endorsement of their programme (figure 3). The AfD won’t be a stable party – its chairwoman Frauke Petry already announced this morning that she would not join the AfD faction in the Bundestag! The FDP, the Greens and the Left all came in around 9-10%. It will be for the first time since 1948 that the Bundestag is composed of six different parties. This can be seen as a reflection of the European-wide trend of political fragmentation. Until now, Germany remained seemingly immune to this, but this was partly thanks to the 5%-threshold.
As we expected and explained in our preview, there will be a lot of extra overhang- and balance seats. As six parties crossed the 5%-threshold and enter the Bundestag, its size is expected to increase from the minimum of 598 seats to 709 seats (see table 1 on the next page). Between 2013 and 2017, the Bundestag had 631 seats. Despite that, the CDU/CSU will probably lose 84 and the SPD 45 seats. The Greens and the Left remain broadly unchanged, while the FDP and the AfD will (re-)enter the Bundestag with 78 and 95 seats, respectively. A final look at the actual outcome versus the latest trend in the opinion polls shows that pollsters did a pretty good job in Germany. Support for the traditional parties was only a tad lower than expected, whereas the FDP, the Greens and the AfD slightly exceeded expectations. It is this slight difference, though, that is having some effect on markets this morning.
Muted impact on markets
In contrast to the French elections there was hardly any tail risk priced in before these elections. The chances of an outright AfD win were always extremely small, if not zero. The German federal elections are also not a binary event, with an explicit ‘market-friendly’ and a ‘market-adverse’ outcome like the referendum on Brexit, but instead present the market a limited set of coalition scenarios and probabilities. The bigger-than-expected win for AfD is at most expected to influence the direction of the coalition talks, as the other parties should still be able to form a coalition without them.
A quick look at the FX options market shows that the German elections have gone by almost unnoticed, especially when compared to the Brexit-referendum, the US presidential elections or the first round of the French presidential elections. The cost of protection against a steep drop in the EUR/USD, which is how the currency was expected to respond following a really adverse result, had barely risen in recent weeks. In fact, positive values for risk reversals indicate that it’s cheaper to buy EUR/USD calls than puts, suggesting that the overall mood remained bullish. As you would expect, this has more to do with central bank policy expectations than yesterday’s elections. This morning, EUR/USD opens slightly lower but the reaction is muted. The pair is currently trading at 1.191 vs 1.195 on Friday afternoon.
There’s also no noticeable reaction in fixed income markets. The yield on 10y Bunds is down 1 bps this morning at 0.45%, whereas peripheral spreads are widening in the order of 1 or 2 bps. The DAX is actually up 0.1% at the time of writing. It shouldn’t come as new that stock market volatility was already low to begin with, but in contrast to the previously mentioned political events, there had been no uptick in implied 30d volatility. In fact, on 21 September the VDAX (or V1X on Bloomberg) closed on a multi-month low of just 11.58%. Forming a coalition based on the election results will be difficult, but political risk-related volatility is currently hardly priced in.
Merkel admitted that she faces difficult talks in yesterday’s Elefantenrunde, which is the roundtable discussion with the political leaders that directly followed the results. There are only two feasible coalitions: a renewal of the Grand Coalition with the SPD (386 out of 709 seats) and the ‘Jamaica’-coalition with the FDP and the Greens (378 seats in total). As SPD leader Schulz currently rules out any role in government for the Social Democrats, ‘Jamaica’ seems the most likely option. A coalition with only the FDP as Merkel’s junior partner is not possible, as we already noted in the preview. This combination would only get 316 seats.
‘Jamaica’ would be the first time that a coalition of three – and technically four! – parties governs Germany. The involved parties are ideologically very far apart. They can find consensus relatively easily on domestic- and fiscal policies, using the government budget surplus as plaster. But on European issues it will be much harder. The FDP (and CSU) have a hard-line position on immigration whereas the Greens have a much more relaxed attitude on this issue. On the EU and the Eurozone the parties are also very far apart. The Greens support an outright transfer union, while the FDP is diametrically opposed to this and instead wants to set up mechanisms for countries to leave the currency union.
It’s likely that Merkel will start talks with the FDP and the Greens, while keeping in close touch with the SPD. The negotiations will take longer than usual for logistical reasons (three instead of two parties) and for ideological reasons, but Merkel is optimistic that she will reach an accord before Christmas.
The Bavarian sister party of the CDU, which is the CSU, likely has a key role in the negotiations. They lost more than 10 percentage points compared to 2013. Therefore they will want to set the party on a rightward track to win back votes from both the AfD and FDP. Indeed, the CSU’s Spitzenkandidat already said this in yesterday’s Elefantenrunde. This rebranding of the CSU’s profile will be especially important to them in the light of next year’s Bavaria’s state elections.
Additionally, the CSU doesn’t want to lend the Greens any legitimacy in the run-up to those elections. They may rightly bet on the SPD to reconsider their stance on government participation if negotiations around a Jamaica coalition fail. So while Jamaica currently seems the most likely outcome, a renewed Grand Coalition is still a significant possibility. The negotiations will not be half as langweilig as the campaign.
The results are a surprise for Merkel. She expected to be able to continue governing with the SPD. The French president Macron likewise expected they could start off quickly with negations about the future of the EU. Both of them will be disappointed with this outcome. The German elections proved not to be the smooth ride as previously expected.