by David Zahn, CFA, FRM, Head of European Fixed Income, Senior Vice President, Franklin Templeton Fixed Income Group
As Germany prepares to go to the polls in a general election, David Zahn, Franklin Templeton Fixed Income Group’s head of European fixed income, considers what the result could mean for Europe, the European Union and the eurozone. He also reviews the recent State of the Union address from European Commission President Jean-Claude Juncker for clues as to what the future might hold for investors.
European Commission President Jean-Claude Juncker’s State of the Union address last week was notably more forthright and aggressive than we’ve come to expect from him. But I think the timing was significant.
These are optimistic times in Europe, in general. In contrast to what many observers might have expected nine months ago, we believe the political structure in Europe is probably the most stable it’s been in 10 years.
Stability Reigns in Europe
Indeed, we’d argue that today Europe is more stable politically than some other parts of the world, such as the United States, where we’d usually expect stability.
From an investment perspective, that stability has been reflected in how investors have been recently allocating their investment dollars. Growing appetite for European assets has corresponded with the perceived improvement in the political outlook.
And while that stability will be tested again later this week as Germany goes to the polls in a general election, a cautious self-confidence was apparent in Juncker’s State of the Union address.
The European Commission president re-emphasised his federalist agenda, outlining a number of approaches designed to bring the region closer together politically and economically. These include a closer banking union, a closer fiscal union, a single European Union (EU) foreign policy and complete adoption of the euro across the EU.
An obvious potential outcome of this push for integration and fiscal union is the emergence of a European bond.
We see this as a long-term issue, but if Europe starts heading down this road we’d expect to see bond and currency markets in the region become more homogenous. That of course also implies there could be less opportunity between the national governments because spreads would likely compress.
Biggest Obstacle to Integration Removed
The reason Juncker’s reignited this debate now, in our opinion, is because the biggest obstacle to increased federalisation—the United Kingdom—is gearing up to leave the club.
While Juncker’s approach calls for greater centralisation of powers, the United Kingdom has argued forcefully against giving away complete authority.
So we think Juncker’s timing is significant, as we expect Brexit to magnify the divisions in Europe between those that want to go for a tighter federal union and those that are more sceptical.
In our view, this week’s general election in Germany could play a significant role in how those arguments play out.
Merkel on Course for Success
At the moment, opinion polls are suggesting that the incumbent Chancellor Angela Merkel should perform well enough in the election to hold on to power. And the market seems to agree.
Once again, she’s likely to have to pull together a coalition government and the interesting calculation will be who her coalition partners are.
We’ll also want to monitor the success of the right-wing populist Alternative for Germany (AfD) party. It’s currently polling upwards of 10%, so although it’s not likely to be part of the government, it could do well enough to win seats in the Bundestag.