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Chancellor Angela Merkel

Germany slows down Europe’s economy

Germany and Chancellor Angela Merkel is back in the centre of the storm, and this time, it affects the financial markets.

The political situation in Germany is currently moving rapidly at a pace that affects even the financial markets. This applies to both the impact on the domestic German economy and the outlook for the whole Eurozone in a broader perspective. This should be seen from a perspective where the planned French-German announcement of major reforms for the Eurozone was delayed in March, due to the six-month long government formation in Germany. In addition, the financial market has been quite optimistic about the growth outlook for Germany, as well as the entire Eurozone since the start of the year – in my view, the risk for a disappointment concerning the growth is growing rapidly, and my assessment is that this weaker scenario has not yet been priced in the stock market, nor the euro exchange rate.

When the French President Macron was elected, it in reality stood on page four in his electoral program that his economic reform of France was based on some financing from the German fiscal budget. As mentioned, it was Macron’s dream that this should have been presented in March at an EU summit, but it was postponed to the EU summit that just took place. It is primarily Macron that pushes for the major reform of the EU, especially the Eurozone. It had even come so far that Merkel would give some support to the reforms, but as everyone has observed the EU Summit went under in a major European dispute about migration.

Seen from Macron’s perspective, the situation is pretty bad. Chancellor Merkel’s own government internally completely disagrees about the refugee policy, which in reality means that she does not know if she has a government to be at the forefront of or not. Important for the financial markets is the link to Macron in terms of Merkel’s support for the economic reforms of the Eurozone. Without Germany, a change of anything in the Eurozone is impossible, but Merkel does not have political backing to enter into any agreements right now. Ahead of the EU summit, several from her parliamentary base even clearly stated that Germany should not open the fiscal budget to other countries in the Eurozone, which underlines the headwind for Macron’s dream.

To make a bad day in the office for President Macron even worse, the grouping called the “Hanseatic League” also addressed their view before the EU summit. The grouping consists of 12 fiscal conservative EU countries, and according to some press reports, the Dutch Finance Minister Wopke Hoekstra was the master behind a letter taking a clear distance to the French dream of a common fiscal budget. Maybe the “Hanseatic League” is less afraid of the fiscal expansion. However, the French idea seems to have something written in fine print about allowing the EU to collect some sort of a mutual tax which really alarms many of the small EU members.

In general, it shows that the EU as a whole is not yet able to generate economic impetus, which has been the financial market’s dream since Macron took over the office. On the contrary, economic reforms and initiatives are still largely left to individual member states where the Southern European members, including France, will continue to have difficulties.

Last year, the euro rose throughout the year, which was partly due to the weaker U.S. dollar. However, a part of the positive development was also based on the aforementioned optimism created by Macron. I expect that disappointments from the lack of progress with the reforms will affect the euro in the coming months. The optimism needs to be corrected, where I estimate that it means a further euro decline of four to five pct. towards the dollar – but what about the stock market?

The European stock market also rose, as influenced by Macron’s optimism, but this year, the stock market is showing signs of fatigue. In my view, the sour market primarily is caused by the pressure of the U.S. interest rate hikes and the threat of an expanding trade war. If my arguments reflect reality, then there is an increasing risk that a further pressure will hit the European stock market – originating from Germany, partly politically driven as described, but the German economic development will contribute as well.

Throughout the spring, I have met many asset managers who have maintained the optimism about the stock market with reference to a higher global GDP growth, or at least a high growth at a stable level. In Europe, there has generally been the same expectation about a continued high economic growth in Germany.

In this year’s first quarter, a number of countries in Europe including Germany have experienced that growth did not fulfil the expectations. Although explained through various reasons that may be right, the persistent political row in Germany obviously does not contribute to further optimism among consumers and businesses. However, the immediate and direct effect in the financial markets I expect to be the mentioned growing pressure on the euro – in the first round.

Source: FRED, Fed St. Louis, USA

The European stock market will react negatively if growth rates for the second quarter disappoints again, and I do not regard this risk as priced in the market yet. My concern is that Germany misses out on the GDP growth again in the second quarter. The business expectations among the large German corporations (graphic one) were pretty much in line with the market forecasts in the latest survey but the readings have been declining for a period now. The detailed developments in the survey show that the construction sector continues its optimism like in all other countries. On the other hand, retailers are significantly less optimistic, and therefore the key figures for German consumer confidence and retail sales during the coming months will be unbelievably exciting. The retail sales data for May that was announced on Friday the 29th June showed the biggest drop in seven years, which contributes to the worry about Germany.

Source: Statischisches Bundesamt, Germany

I expect that many in the financial market will look out for hints about the German GDP growth for the second quarter. Another hint is the the factory orders (graphic two) that started the quarter badly in April with a reading below the expectations. Therefore, the next four to six weeks will be incredibly exciting where I see an increased risk that the pressure on the European stock market will continue.

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