As if this week did not have enough political risk baked in, the German government collapsed tonight, setting the stage for early elections--and thus a government led by center-right CDU leader Friedrich Merz: a bullish outcome for the German economy. The most likely scenario, laid out by Chancellor Olaf Scholz, calls for elections at the end of March.
Who did that?
We have argued since at least September that the German coalition government was in trouble and at risk of early elections.
Today, after a significant disagreement over fiscal policy, Chancellor Olaf Scholz (SPD) fired his Finance Minister Christian Lindner (FDP).
In doing so, he essentially signed his own government's death warrant, as the so-called "traffic light coalition" relies on the FDP for its majority in the Bundestag.
The decision is designed to blame the FDP for the coalition's collapse--and was seemingly reached in agreement with the junior coalition partner Greens.
What are they fighting about?
Primarily fiscal and security policy--Scholz was seeking an exemption from Germany's constitutional debt brake to loosen fiscal policy using national defense and support for Ukraine as an excuse. Lindner apparently refused to budge.
In reality, the three-way coalition has been dysfunctional since at least this time last year, when the Constitutional Court forced them to enact emergency austerity.
The governing parties were punished for this in September's regional elections, where populists of the right and left triumphed in Eastern German states.
What happens now?
In a well-prepared press conference that followed Lindner's dismissal, Scholz laid a three-way plan: he will try to pass this year's legislative initiatives, including "support for industry," and pension stabilization measures, as well as the incorporation of new European asylum legislation into national law.
Second, he will seek a vote of confidence in the Bundestag on January 15--which he fully expects to lose. This would lead to elections by the end of March.
In his statement, Scholz also mentioned that he would be reaching out to opposition leader Friedrich Merz to seek pragmatic solutions.
Who's next?
Friedrich Merz leads the center-right opposition CDU party, which is currently polling first around 32% -- comfortably ahead of its 2021 result (24%) and the SPD (currently at 16%).
The Greens are polling around 10%, the FDP below the parliamentary threshold of 5%.
Far-right populists AfD are at around 17%, while far-left populists BSW are polling around 8%.
It is almost certain that Merz will be the next German chancellor, though he will likely need a coalition with the SPD to get elected.
Until now, the CDU has shown itself comfortable with political coalitions across the political spectrum, with the exception of the AfD.
It is likely that this policy will continue as the German electorate still finds the idea of the far right in government relatively repugnant -- any hint of association with the AfD could see the CDU punished in the election, and Merz will seek to avoid such a fate.
Macro, please
German rates actually rallied today, bucking the global trend that followed Trump's election in the United States. 10-year rates are now at 2.4%. (for more on the macro reaction to Trump, see our Special Issue from earlier today here)
We doubt Merz will revisit the debt brake in his first term and expect the ECB to overshoot in its tightening, so there remains some upside for German bonds that could be amplified by a spendthrift Congress in the U.S.
More broadly, we view the end of the coalition government and Merz's likely ascendance as a positive influence on German entrepreneurship and economic activity, which has been notably lackluster since the pandemic.
Despite positive population growth, German real GDP is essentially flat since 2019.
European equities remain relatively cheap by developed market standards, and a level-headed German government with a mandate for structural reform could lift all boats. It is certainly a good time to be looking for opportunity in the region.
All best,
Dimitris.
To book a meeting with me to discuss these or any other Aurora themes contact juliet@auroramacro.com
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