Forex Trading Library

How Could the Markets React to German Elections?

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Forming a new government in Germany will be a complicated affair. Nonetheless, the voting and the counting of votes on Sunday will run with the typical German efficiency.

What’s likely to rile up the markets for a while afterward is the expectation for extended and difficult coalition negotiations. There is a distinct possibility that the procedure will take up to months, and depending on how it goes, it could push the markets around.

What’s going to happen?

The thing is, all the polls show that no single party is going to win a majority.

Initially, polls favored the CDU and the potential of a continuation of the current governing conditions. Then the Greens came to the fore and now the SPD is leading in the polls.

Regardless of which party comes in with the most votes, the resulting negotiations are likely to be difficult and extended. In turn, this could lead to some unexpected results.

There has been increasing popular strain on the “grand coalition” that is currently governing Germany, led by the center-right CDU with the center-left SPD as junior partners.

In fact, both sides are irate with this arrangement. This is because the right feels like they are compromising too much, and the left is frustrated with the inability to get their initiatives through.

The SPD has promised to not form a coalition with the CDU again… just like they did the last time, and the time before that.

Where the difficulty lies

The issue remains that the minor parties that would otherwise serve as kingmakers don’t get along. No one wants to work with the AfD, who we can expect to get around 10% of the vote, which makes it that much harder to form a coalition.

The press has also been discussing governing alternatives, such as the so-called “traffic light” or “Jamaica” coalitions, implying a coalition between the Greens and the FDP.

However, the Greens advocate for tax and business policies that are completely at odds with the core free-market values of the FDP. This would make such a coalition virtually impossible at the Federal level. The thing is, these two options are the most likely to form a majority.

As for the ‘traffic light’ reference, the names come from the colors of the parties. The “traffic light” is led by the SPD (red), including Greens (green) and FDP (yellow). The CDU (black), FDP (yellow), and Greens (green) would lead an alternative “Jamaica” coalition. Those two options would be the most likely to preserve the status quo and keep the markets from reacting too much.

Where the risk lies

Nevertheless, there is a further possibility that the SPD and Greens could get enough votes that they form a coalition with the Linke, or the far-left (also red).

This would be a radical leftward shift in the government’s politics. The expectation is that it would push bond yields up, weigh on the stock market, and strengthen the euro. Climate stocks would likely benefit from this, but cyclical stocks would likely be under pressure.

The other alternative for a shift in policies is if the SPD gets a small majority, and will have to return to a coalition with the CDU, or with the FDP. Analysts expect this to be positive for the economy, support the stock market, and lower bond yields. And they would also anticipate a weaker euro because of this.

The initial market reaction is likely to depend on the expectation for which one of these scenarios will play out. And then this would adjust as negotiations progress or break down.

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