The federal election in Germany on 26 September not only marks the end to Angela Merkel’s 16-year reign as chancellor, but also brings the chance of a policy shift that could influence the future path of the German economy and the institutional set up of the European Union (EU).

Investors should keep in mind that the direct impact of elections on German asset prices have historically been limited, due to continuity in leadership and economic policy. That Germany has had only three chancellors in the past 40 years reflects this stability.

However, this election could be different. While current finance minister Olaf Scholz of the Social Democratic Party (SPD) is leading in the polls to be the next chancellor, followed by Armin Laschet for the Christian Democratic Union/Christian Social Union (CDU/CSU) and Annalena Baerbock for the Green Party, there is a high likelihood that for the first time in 60 years the German government has to be formed from a three-party coalition.

Public support for the current “grand-coalition” between the CDU/CSU and the SPD has dropped from 69.4% in 2005 (the first Merkel government) to 47.6% in the latest polls. This rising unhappiness with both main parties will likely put an end to the coalition that governed Germany for the last eight years.

The main German political parties and their policy goals

To get a sense of what is at stake, we’ve summarised the policy objectives of the main parties contesting the election. 

• CDU/CSU: The largest centre-right party is still viewed as conservative and more business friendly, although it adopted a more progressive policy regarding re-distribution and immigration in the Merkel years. The CDU is rejecting tax hikes and fiscal transfers to the EU, is proposing a cap on corporate taxation at 25%, and is committed to a balanced budget.

• Free Democratic Party (FDP): The free market centre-right FDP is promoting more investment in technology and no tax increases, and wants to lower the regulatory and tax burden for corporations. Fiscally, the FDP is on the conservative side.

• SPD: The largest centre-left party is championing more re-distribution and social transfers, and strongly opposes further austerity. It would raise the top income tax rate to 45%, and introduce a financial transaction tax and a wealth tax. The SPD is supportive of fiscal transfers inside the EU and promotes further fiscal integration.

• Green Party: With a strong climate change agenda, the centre-left Green Party is promoting a significant increase in climate-related public investments and therefore opposes the debt brake. The party would set the top income tax rate at 48%. The Greens support the EU Green Deal and further fiscal transfers inside the EU, along with stronger regulation of the banking industry and the real estate market.

• Die Linke: On the radical left, Die Linke is demanding a massive re-distribution of wealth, price controls in the real estate market and optionality to expropriate real estate companies. The party would introduce a minimum monthly income of EUR 1200 for people on welfare.

Potential coalition governments

The road to forming a new government in Germany looks difficult because of the voting system. Any party that receives more than 5% of the popular vote gets a representation in the Bundestag (the German parliament) that is equivalent to their vote share. Recent polls are indicating a further fragmentation of the political party system, with six parties expected to be above the 5% threshold and no party expected to receive more than 30% of the vote. Such a result would make the formation of a three-party coalition government very likely. 

However, finding common ground between three or more parties so that a stable government can be formed will be a challenge. The breakdown of coalition talks between the CDU, FDP and Greens after the last election in 2017 is a good example of the difficulties faced in the negotiation process. Lengthy negotiations should be expected until the new government can be sworn in. In 2017, it took more than five months to form a government. 

To see how things may pan out, we can look at the coalition options that are currently on the table. All parties have ruled out a coalition with the right-wing Alternative for Germany (AfD) party, while the centre-right CDU/CSU and FDP have declared that they will not join a coalition with the left-wing Die Linke. This leaves us currently with six coalition scenarios, shown in Exhibit 1 in declining order, based on the number of seats in the Bundestag out of a total of 598¹ .

Exhibit 1: Potential coalitions based on latest polls

Number of seats in Bundestag per party

Source: www.bundestagswahl-2021.de, J.P. Morgan Asset Management; data as of 14 September 2021.

Because of the slim majorities offered in most of the coalition scenarios, the still significant amount of undecided voters and the margin of errors in polling, it’s impossible at the current time to forecast with any high degree of confidence which parties will be involved in the new government. Nevertheless, the polls do suggest a remarkable shift in voter preference that shouldn’t be left unnoticed. Compared to the last election in 2017, the latest polls indicate on aggregate a huge shift in voter preference from the right side of the political spectrum (CDU, FDP) to the left.

The two centre-left parties, the SPD and the Greens, are looking to gain more than ten percentage points in the popular vote, which should significantly strengthen the progressive and climate change agenda in the next elected parliament (Exhibit 2). After election day on 26 September, Germany is likely to move politically to the left. How far it moves will be determined by the number of left wing and left-leaning parties in the next coalition government.

Exhibit 2: Election polls - gain and losses in popular vote vs. Last election in 2017

In ppt; average of last 5 polls

Source: www.bundestagswahl-2021.de, J.P. Morgan Asset Management, Data as of 14 September 2021

Market Impact

The weight of German equities in the MSCI Europe Index is close to 15%, and close to 3% in the MSCI World. Therefore, the market impact of the German elections should be limited. However, a significant shift in economic policy in Germany could have a longerterm impact on investment opportunities across Europe.

The biggest risks for markets in this context would be a three-party coalition of the left that includes the radical left-wing party, Die Linke. In this case, German economic policy would be expected to shift dramatically towards bigger government and wealth re-distribution. Higher government spending, an increase in the minimum wage, higher taxes and significantly more regulation for the industrial sector can be expected in this scenario, which is a particular risk for the mid- to long-term prosperity and growth potential of the EU’s largest economy and could lead to some uneasiness among equity investors.

With all three left-of-centre parties promoting price caps on rents, German real estate would also receive a significant hit in the event of an SPD/Green/Die Linke coalition. The Green Party additionally wants to increase energy standards, not only for new properties, but also for existing buildings.

While a left coalition including Die Linke is certainly a risk for Germany, the EU’s view on such a government is probably less negative. All three left wing and left-leaning parties (the SPD, the Green Party and Die Linke) strongly favour a fiscal union and the continuation of the EU recovery fund.

For government bond markets, the risk dynamics are a bit different. A new coalition government that includes the CDU/CSU, and particularly the FDP – which is a strong champion of austerity and the Maastricht criteria – could keep spread risk alive inside the currency union. A more left-leaning government, in contrast, would very likely lead to further spread compression between the periphery and German Bunds, driven by the perception of higher government spending in Germany and support for new less stringent fiscal rules in the EU, and the acceptance of fiscal transfers.

Key take aways:

• After election day, the polls suggest Germany is likely to move politically to the left

• The formation of a new coalition government is complex and could take many months

• Germany could introduce further climate policies and strengthen its support for EU integration

• The direct market impact is likely to be limited, but any left-ofcentre coalition that includes the radical left-wing party, Die Linke, would be the biggest risk to markets