(Bloomberg) — Germany’s highest-stakes election in years is paving the way for a pivot to increased spending, with markets predicting the end of an era for constrained fiscal policy.
The euro will be in focus when traders return to their desks from 5 a.m. in Sydney on Monday, just an hour after polls close. The currency has so far largely shrugged off the potentially far-reaching consequences of the vote, prompting fears about complacency in the event of an unclear or shock result; another risk is a better-than-forecast performance for the far right. Bond and stock futures begin trading at 1 a.m. in Berlin.
With no party expected to win a clear majority, investors are counting on the center-right CDU/CSU alliance — led by Friedrich Merz — to come out on top and form a strong coalition with one or two other mainstream parties. Such an outcome would likely ease the path toward reforms that could reboot Germany’s moribund economy — and enable changes to a constitutional limit on borrowing, introduced in 2009 and known as the debt brake.
That would mark a seachange for Germany, which has long preached fiscal prudence. But with the US pushing Europe to spend more on defense, such a shift is now on the table.
These are the “most meaningful elections this year,” Kim Catechis, an investment strategist for the Franklin Templeton Institute, wrote in a note. “The policy direction taken by Germany in the next four years will set parameters for the European Union and by extension, have a significant impact on the world economy.”
Assets have started to price the prospect of a result that supports further borrowing: German bonds have slipped versus key benchmarks, with longer-dated securities falling more than those with shorter maturities, pushing the yield curve to its steepest since 2022. That’s because additional borrowing tends to weigh more on longer tenors.
Meanwhile, the country’s benchmark DAX gauge of stock prices has climbed to a record high — driven in part by a 45% rally this year by Rheinmetall AG, the only pure-play defense stock in the index — and euro currency options are tilted in favor of more gains early this week.
Companies in the defense sector are poised to benefit from any fiscal reform that frees up capital for more investment in Europe’s military. These stocks have already been on a tear this year, with Citigroup Inc. analysts noting before a rally last week that boosting spending on defense to 2.5% of GDP, up from 2%, would increase equity valuations of these companies by 15-20%.
The euro has benefited from the inflows into German stocks this year, and closed the week at $1.0458. The common currency is on track to gain almost 1% in February, its best monthly performance since August. And data from the Depository Trust & Clearing Corporation show that 60% of options placed this year to expire Monday are targeting a stronger euro. That’s despite broader concern that the currency could ultimately fall through parity with the dollar this year.