Germany: Code Red!

Farewell Angie, Hello Olaf! The SPD leader Olaf Scholz is in pole position to become the next Chancellor of Germany after the Phoenix-like resurrection of his party from the electoral wilderness. This is thanks to his appeal as the least worst option after the Chancellor Candidates of the other two largest parties spectacularly imploded over the course of the campaign. Firstly, the lamentable Laschet of the CDU managed to find himself caught on camera laughing whilst visiting a flooded town in July; then the Green Party’s Annalena Baerbock suffered a string of damning accusations including that she inflated her CV and plagiarised sections of her book. By comparison, the current Finance Minister looks like a safe pair of hands.

But his position as Chancellor isn’t guaranteed. Although the SPD are currently top of the polls with 25%, that’s a far cry from their historical average haul of 32% in all elections since reunification. The last time they were in power as the majority coalition partner (in 2005), they were capturing closer to 40% of the vote.

So they will certainly need a partner. In recent times that has come in the shape of the CDU/CSU, but with their vote share skidding around 20%, that is unlikely to generate enough seats to form a stable majority government.

Step forward the Greens. They’re set for their best ever result, even with the dip in form following Baerbock’s woes. At the last election they took 9% of the vote and current polls have them winning around double that. The SPD and the Greens therefore look assured for positions as the main parties in government.

So much, so left, so green. But on current polling, a third party will be needed. This is where the market will focus. Will they choose the business-friendly, budget-balancing FDP led by the charismatic Christian Lindner? Or will it be the ex-Communist Die Linke, the Left Party?

If it’s the latter, the spending spigots will be turned up to 11, and you’d expect Bund yields to soar while the Euro swoons at Communists entering the hallowed German government. If it’s the FDP, then with Lindner at the helms of the finance ministry, some fiscal rectitude will be restored, stabilising yields and the Euro.

After all, Lindner just gave a candid interview to the FT where he could not be more explicit about his priority for a balanced budget, explaining that ‘The prerequisite for us joining any coalition is that we can’t have tax increases and we respect the constitutional debt brake’. The debt brake was implemented following the bailouts from the financial crisis, writing into German law that the structural budget deficit must not exceed 0.35%.

But this law has already been suspended due to the pandemic. Germany has just clocked its largest budget deficit in thirty years. And once the spending spigots are switched on, they’re very hard to switch off. Not least when the central bank is hoovering up all that debt.

For this election, then, Germany is going left and going green. Lindner might be the only man left standing on a policy of prudence – and as such, be left out in the cold. His ideological bedfellows on the right, the CDU/CSU, have even had their wobbles over Germany’s famous “Schwarze Null” obsession (Black Zero, denoting a balanced book).

Merkel’s Chief of Staff wrote an op-ed to Handelsblatt in January this year admitting “the debt brake cannot be adhered to in the coming years”. Laschet promptly slapped him down but then cunningly created the concept of a “Germany Fund” to invest in infrastructure. Despite claiming that “we can’t allow a situation to arise where you’re circumventing the government’s debt management policy”, that’s exactly where he’s heading. The leader of his sister party, Markus Söder of the CSU, has even flirted with the idea of climate policies being ringfenced outside of the constitutional rules.

If even the pragmatic centre-right are considering extra spending on green measures, Germany’s future is clear. More spending, more deficits, more debt – and hopefully, as a result, more growth. This is a paradigm shift from Europe’s largest economy, and, as such, will change the direction of the Eurozone. Having struggled with deflationary demons, the inflationary chickens will now come home to roost. If they’re accompanied by growth, then the Eurozone might just finally shake off its sclerotic shackles and become the tiger economy for the 21st century.

There is one more hurdle it must overcome. For the Eurozone to thrive, its monetary and fiscal institutions must become more integrated. Merkel was always committed to “ever closer union”, and Laschet, as a former MEP, even more so. Olaf Scholz has gone a step further; he greeted the massive Next Generation EU fiscal stimulus as its “Hamiltonian moment”, referring to when the United States federalised the debts of individual states in 1790. The Greens are similarly on board. But Die Linke, the FDP and the AfD have reservations about the European project, or at least the need to preserve some German freedoms within it. So even if the FDP join a SPD+Greens coalition, tempering fiscal profligacy, they will raise the risk premium for German assets due to their stance on Eurozone institutions.

It is Code Red for Germany after September 26th. The end of Merkel leads to the beginning of much more risk.

Stocks slip ahead of Jackson Hole, wobbly German economic confidence

Morning Note

Risk takes a pause: Stock markets dropped in early trade on Thursday and the dollar rose a touch ahead of the Jackson Hole meeting, whilst wobbly German confidence knocked the wind out of this week’s rally in Europe. The major bourses were roughly 0.5% in the red at the start of the session, coming off a decent rally so far this week and another set of records on Wall Street. In London, 7-1 decliners to advancers indicates the broad selling with just healthcare keeping in the green in the early part of the session with AstraZeneca doing all the work. Basic materials is the weakest sector with all the major miners in the red. Characterise today as risk talking a pause for breath after a solid run this week.

There’s a strong sense of anticipation ahead of Jackson Hole. Rates are on the move, with the German 10-yr bund at a month-high. All eyes are on Fed chair Jay Powell on Friday, though markets seem relatively comfortable that either course he takes will ultimately not create a taper tantrum – we will see. Minutes from the last FOMC meeting clearly stated that most participants expect to be tapering this year. This does not mean the Fed needs to send a clear message to the market this week. Powell can keep some dry powder and wait for the September FOMC meeting at least. The last couple of weeks have shown growth momentum fading and US covid cases spiking, but it’s also showing inflation is proving to be sticky. If anything what we are seeing is just how difficult it will be to exit such a huge policy response (to the pandemic) without serious repercussions – be they inflation scarring, financial stability, financial bubbles or whatever. South Korea lit the torch as the country’s central bank raised rates overnight from 0.5% to 0.75%.

Germany’s GfK consumer sentiment declined to –1.2, data this morning showed. It comes after the Ifo business climate index declined for a second month as supply chain problems and rising covid cases worried companies. Another worry emerged as the EU may reimpose travel restrictions on the US. UK car production has hit lowest since 1956.

Slow appreciation: Wall Street rose again for fresh records, with the S&P 500 breaking above 4,500 for the first time and the Nasdaq closing north of 15,000. These look like prime areas for a pause. Bond yields are higher, with 10s at 1.34% and the reflation-reopening trade probably has more legroom than mega cap tech/growth/momentum names, though the latter is not yet blowing up like it has done in previous episodes. Yesterday the biggest contributors to SPX were big banks, whilst pharma and health dragged. Market breadth still not great but better and momentum is decidedly slack but the buy-the-dip conditioning has yet to be really tested by a really aggressive selloff or major policy/economic surprise. Delta concerns are probably less than they were two weeks ago even as cases rise, with markets more comfortable that companies can weather any rise, whilst the kind of ultra-lockdowns are behind us in the US, UK and Europe.

Jobs boom: Recruiter Hays said that despite an 8% drop in fees in the year to June 30th, trading improved through the year, with strong sequential growth in all regions. First half fees down 24% but in the second half they were up 13%. Management also noted a sharp increase in permanent roles in the second half, whilst the temp business has remained quite resilient. Chief executive Alistair Cox said the company sees a “clear route back to, and then exceeding, pre-pandemic levels of profit, faster than we envisaged even six months ago”. Bullish and reflective of the strong economic rebound and business demand for staff as they seek to fill headcount.

Crude oil inventories fell for a third week and fuel demand hit its highest since March 2020, figures from the EIA showed yesterday. Inventories at Cushing rose for the first time in 11 weeks, however. Price action is a little weaker today as spot WTI wrestles with the 100-day and trend resistance. Delta worries seem well priced – question is still whether the physical market continues to tighten over the rest of the year and this will be all about demand recovery. Closure of travel routes into the autumn (see EU on US) could knock confidence.

Spot Oil Chart 26.08.2021

Gold continues to drift lower, now under the 50-day SMA and sitting in the middle of the Bollinger range. $1,774 offers the near-term support should the price continue to drift back, which could then see a test of $1,760. Resistance offered at the $1,800 – $1,810 round number – 200-day SMA area.

Gold Chart 26.08.2021

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