By Jamie McGeever
Germany’s election on Sunday is at once the most mundane political event of the year for markets and a defining moment that could shape Europe’s future for a generation.
Angela Merkel is widely expected to be re-elected chancellor and Wolfgang Schaeuble is set to remain as finance minister, retaining their posts as two of the most powerful and influential politicians not only in Europe but the world.
Even if voters deliver a stunning upset on Sunday, the immediate market impact of centre-leftist Martin Schulz becoming leader and Schaeuble stepping down would be minimal. Consensus-driven German politics gives populism little room to flourish, and most of the mainstream parties are fully committed to Europe and the euro project.
Either way, closer and stronger cooperation with France will follow, which should strengthen the euro zone’s foundations. The longer-term implications for the euro zone, the European Central Bank, European integration and the euro zone’s 12 trillion euro economy could be hugely significant.
The foundations of the euro zone’s markets and economy are the strongest they’ve been since the global financial and euro debt crises. Growth across the 19-nation region is the fastest it has been since 2011, and the bloc no longer appears on the verge of collapse.
That’s not how it looked on Jan. 1. The narrative then was that the European electoral cycle of 2017 posed the biggest risk to world markets for the year, that populism would push France to the far right, and that talk of a euro zone breakup would resurface.
Those who bet on that got burned. Scottish hedge fund manager Hugh Hendry last week closed his fund Eclectica Asset Management, which had lost 9.4 percent in the first eight months of 2017 and 4 percent in 2016. Over the past two years, Hendry had bet on the breakup of the European Union.
Further euro zone integration hinges on the Franco-German axis being strengthened, a ‘sine qua non’ for stability and tackling Europe’s structural and governance issues, according to Philipp Hildebrand, vice chairman of BlackRock and former president of the Swiss National Bank.
With centrist and euro integrationist Emmanuel Macron having swept to power in Paris earlier this year, France is ready. Merkel or Schulz will be willing partners, and issues like a euro zone finance minister, common budget, and closer corporate tax harmonization policy are all on the negotiating table.
And the timing couldn’t be better for closer ties between Paris and Berlin. Most euro zone countries are complying with the bloc’s budget rules, growth is strong, and popular support in Germany for more integration is high.
Whoever wins may feel they have to deepen ties with France regardless. The Trump presidency in Washington, Brexit, security and terrorist threats, and the refugee crisis all suggest Germany needs to help create a stronger Europe and therefore needs a closer relationship with France.
“Merkel needs France more than ever,” notes Erik Nielsen, chief economist at Unicredit.
Euro zone markets certainly got a boost from the French election when it became apparent the anti-euro far right was heading for a heavy defeat. The euro is up more than 10 percent since the first round vote on April 23, and between that day and the second round runoff on May 7 euro zone stocks jumped to what has so far been the high point of the year (although the strong euro has since doused those flames).
Germany has long insisted on other euro zone countries improving their finances as a condition for pursuing greater fiscal integration on the euro level. As analysts at UBS note, euro zone countries’ fiscal deficits are on track to average just 1.4 percent of GDP next year, and solid growth has underpinned support in Germany for more integration.
If Merkel’s re-election is fairly certain, Schaeuble’s eight-year tenure as finance minister may be less assured. Even if he were to be sacrificed as part of a new Merkel coalition, he is unlikely to depart the euro zone financial stage.
Eurogroup president Jeroen Dijsselbloem’s term is up in a matter of months, and Jean-Claude Juncker steps down as European Commission president in 2019. Could Schaeuble be in line for either of those positions?
The obvious implication for Europe would be greater fiscal discipline. And for monetary policy, a German heading up the Eurogroup or the Commission would make it less likely that European Central Bank president Mario Draghi’s successor in 2019 is also a German.
Stricter discipline on the fiscal side could give the ECB more room to go slow in unwinding its quantitative easing bond-buying stimulus. This would provide a more positive backdrop for bonds but perhaps less so for the euro – an ideal growth-friendly mix for euro zone policymakers.