Angela’s Next Step

Angela Merkel (with FranÇois Hollande) can look forward to four more years of greeting fellow world leaders. Source: Getty Images.

Angela Merkel cruised to a third term as German Chancellor on Sunday, ensuring four more years of awkward photo-ops with fellow world leaders who aren’t sure how best to greet the good lady (hint: back rubs not recommended). But Germany’s election saga is otherwise far from settled. Merkel must now form a ruling coalition, which could take weeks of horse-trading over policies and cabinet appointments. Whatever the government’s eventual makeup though, the status quo for the eurozone and relative quiet on the domestic front seem likely, which should keep markets happy.

With 41.5% of the vote (and 311 of 630 seats), Merkel’s Christian Democrat Union (CDU) and its sister party, the Christian Social Union (CSU), fell just five seats short of an absolute majority. That slim shortfall, however, doesn’t mean forming a government will be easy. The CDU’s traditional ally—and outgoing coalition partner—the Free Democratic Party (FDP) fell below the 5% threshold to be represented in parliament. So Merkel will have to turn left and likely make some key concessions in the process.

The likeliest outcome appears to be a so-called “grand” coalition with the Social Democrats, who won 25.7% of votes (192 seats). Merkel and the CDU governed with the SPD during her first term (2005-2009), and SPD leader Peer Steinbrück was her finance minister, so the parties have a recent history of cooperation. However, this doesn’t mean they can or will form a coalition overnight. The SPD is still smarting from 2009, when its association with the CDU was widely blamed for its loss of 76 seats. To many SPD leaders, reteaming with the CDU likely carries significant political risk—and as compensation, they’ll likely demand key cabinet positions (the Finance Minister post is rumored to be at the top of their list) and policy influence. Merkel and the CDU aren’t keen to give much ground—especially with what they see as a firm mandate—so the parties could haggle for weeks (potentially longer).

SPD isn’t Merkel’s only option—the Greens, which captured 8.4% of the vote (63 seats), could also enter the picture. However, CDU/CSU and the Greens remain divided on Energy policy, namely nuclear reform. The Greens are also wary of repeating the FDP’s experience—like the SPD in 2009, FDP’s four years as junior coalition partner are widely blamed for their electoral woes. Then again, their apparent wariness could just be jockeying for position, and they may yet back off from recent tax hike proposals—and accept some political risk—in order to achieve some semblance of power.

Either way, for Germany’s eurozone partners, not much will change. The CDU/CSU, SPD and Greens all supported the periphery’s bailouts and favor more regional integration, albeit to varying degrees. While Merkel is often cited as an unshakable austerity advocate, her seemingly tough stance in recent years was more a result of FDP influence—with SPD or the Greens at her side, she might very well be at least a bit more flexible should other nations (ahem, Greece) require further assistance (and the SPD is already pushing for easier fiscal policy in the region). Germany’s position on the banking union should be similarly unchanged—Merkel remains supportive of the idea of a single supervisor but cool toward plans that would require treaty changes. The SPD is more open to things like Eurobonds but likely won’t have the clout to overcome Merkel’s resistance.

On the domestic front, should a CDU/CSU/SPD grand coalition prevail, domestic policy likely focuses on the common ground among all parties, like shifting energy costs and subsidies for alternative energy from consumers to businesses and establishing rent control and wage floors in areas with no collective agreement. Tax policy likely stays moderate—the targeted tax cuts the CDU/CSU advocated might not happen, but tax hikes appear highly unlikely. Domestic policy likely looks similar if the Greens get the nod, though perhaps with more of a push for renewable energy. Either way, extreme change appears highly unlikely. In general, coalitions just don’t pass much—too many differing views and competing objectives. Plus, the CDU still has a minority in the upper house, which must approve measures impacting Federal administration (law, industry, welfare, private property, etc.).

In other words, gridlock wouldn’t surprise—and in a country like Germany, which has a competitive economy, that’s a fine outcome for markets, which tend not to like legislative risk. Heated coalition negotiations might give the appearance of political uncertainty—which can drive volatility. But over time, with domestic policy likely tame and support for the periphery remaining intact, stocks should find plenty of reasons to move higher.