German Elections Preview

The key points to watch in Sunday’s German parliament elections:

The first point traders will watch is whether eurosceptic party anti-euro Alternative for Germany (AfD) secures the minimum 5% vote required to enter parliament. AfD entry would trigger an immediate sell-off in the euro, widen peripheral spreads and raise questions about Germany’s position as a strong leader in Europe.

The 2^nd immediate point to watch is whether the current ruling coalition of Angela Merkel’s Christian Democratic Union (CDU) and the Christian Social Union (CSU) with the Free Democrats and FDP, will be maintained, or replaced by a Grand coalition of CDU/CSU and the Social Democrats (SPD).

Since both major parties – CDU and SPD refuse to form a coalition with the ADF, then if the latter enters parliament, Merkel’s CDU is forced into a grand coalition with the SPD.  This would be similar to Merkel’s first term, when she navigated into the 2008 crisis with SPD chief serving as Finance minister at the time.

While neither the current coalition with the FDP, nor a Grand coalition with the SPD is synonymous with significant push for “more Europe”; either of these outcomes is preferable for the euro to having AfD in parliament.

Thus, the response to a Grand coalition will depend on the success of AfD.

A Grand coalition led by the Merkel bloc would imply less political uncertainty than the weaker majority under the present coalition of CDU/CSU & FDP. Such coalition will also likely soften Germany’s tough austerity stance as the Social Democrats support more growth-driven policies in Germany and the Eurozone.

Considering that a Grand coalition would be more receptive to broader Eurozone integration and an activist ECB, such point might be capitalized upon by eurofiles and sceptics alike to make their argument heard for and against more integration.

But also note that a continuation of the current coalition would be seen as a positive for growth from a fiscal stand point (more stimulative tax policies), especially as Germany avoided a double dip recession in Q2.

According to the latest polls, Merkel’s CDU leads with 40% with her CSU partner at 5%. The FDP at 6% , Social Democrats at 27%, the Greens at 9% and the ADf at 5%

FX Impact  

Considering the above analysis, the election impact on the currency appears generally positive. Barring any knee-jerk reaction from AdF entry into parliament, buying on the dips is likely to follow ahead of next week’s release barrage of Eurozone manufacturing  and services PMIs as well as German Ifo, all of which are expected to continue edging higher. This week’s euro rally was largely a case of USD weakness resulting from the FOMC decision not to taper. Starting from Sunday, the focus shifts to Germany, which could well add momentum to the latest euro drive. $1.3670 remains a preliminary objective for €/$.