“In our view, the outcome of the German election could have implications for the balance of power in the EU, especially in the Franco-German relationship,” says David Zahn, head of European fixed income at Franklin Templeton investments.
Macron vs Merkel
That Merkel will win the elections is perhaps a foregone conclusion. But the question who will be her coalition partner is not. The answer will decide who will take the lead in the Franco-German axis that will shape the future of the eurozone: France’s new president Emmanuel Macron or Merkel?
“We could find ourselves in a situation in which two leaders are vying for the leadership of Europe,” says Zahn.
And the question who Merkel’s coalition partners will be is likely to decide the outcome of this battle.
Merkel’s preferred coalition partner is the liberal, fiscally conservative FDP: this party is firmly against establishing a separate budget for the eurozone, and turning the monetary union into a fiscal transfer union, as proposed by the French president.
A ‘fiscal union’ will involve pooling sovereignty and is likely to lead to economic and monetary convergence, reinforcing the spread compression between core and peripheral bonds that we’ve seen this year. It is therefore important for bond investors to watch.
Opinion polls suggest it is uncertain the FDP and Merkel’s CDU/CSU will garner enough votes to form a majority government. If that happens though, Merkel is likely to push for preserving the status quo, since that’s her natural inclination and because she will be pressed by the FDP to resist any further fiscal integration.
Such an outcome to the elections is therefore likely to push bund yields lower, while it may exert pressure on peripheral bond yields in the months to come.
Under this scenario, Macron’s ambitions are likely to be watered down significantly by an emboldened Merkel, who will continue as Europe’s de facto leader.
Coalition complications
But things get a little complicated, if Merkel needs an additional partner to form a majority coalition. The only candidate for a three-party coalition will be the Greens. Coalition negotiations will be complicated however, considering the big ideological differences between the three: not least when it comes to fiscal integration in Europe.
While the outcome of such negotiations is uncertain, Angela Merkel will surely be consumed by the complications such talk entail.
That will give Emmanuel Macron the chance to garner support for his plans in the meantime, though he will be aware that he won’t be able to execute them without support from Europe’s biggest economy.
The third option on the table is a continuation of the current coalition between Merkel’s CDU/CSU and the social-democrat SPD. This is option is not preferred by the SPD however: they prefer to go into opposition since they are expected to lose seats.
But this outcome will give Macron the best shot to execute his plans: the SPD are led by the Europhile former president of the European Parliament Martin Schulz, who is likely to ask a heavy price from Merkel for agreeing to continue in government. And that may well include lending support to most of Mr Macron’s plans.
If only for sheer political opportunism, Mr Schulz will be more than happy to see the French president taking the lead in Europe, as this may diminish Merkel’s political standing at home. But Merkel will be aware of this risk, and will do anything to avoid such a situation. Pulling off a resounding victory on Sunday will go a long way in doing so.
