German election: a CDU-SPD coalition still baseline with ‘fatter’ tail risks at the margin

Germany

Annalisa Piazza (MFS Investment Management) | Following the eventful discussions and a non-binding motion on immigration approved by the Bundestag last week, the focus ahead of the February 23rd election is now shifting more towards immigration rather than the economy (and its structural problems). Given that Friedrich Merz made it clear that the CDU would not form a coalition government with AfD, a CDU-SPD coalition remains the most likely outcome in our view. The chances of a repeated election might marginally increase should the outcome be inconclusive (for example, the CDU and SPD end up with a very modest majority) as a coalition with the Greens is unlikely due to significant divergent views on immigration.

From the sovereign market perspective, we expect the current political turmoil to have a limited impact on Bunds. Swap spreads have moved well in advance and are already pricing in some political and policy changes (such as more fiscal space). We expect the Bund curve to remain the ‘safe-haven’ for EGBs in the medium term.


On the FX side, the outcome of the German elections will be watched as Europe is currently lacking strong leaders (Meloni alone cannot really make decisions). In the current uncertain environment of trade wars and increasing risks when it comes to growth and defense, markets will be carefully watching whether Europe is able to provide a coordinated response to these challenges. At the moment it is difficult to see that as regardless of the outcome of the German elections, it will take weeks (if not months) to form a government in Germany. As such, we expect the EUR to remain under pressure.

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