German Elections Likely Negative EUR, Japanese Election Neutral Yen

Summary

• Germany and Japan head to the polls in autumn.
• In Germany, the base case scenario is a CDU/CSU, SPD and Greens coalition, which would keep fiscal policy unchanged and lead to further monetary stimulus.
• The risk case scenario in the German elections is a SDP, Green, and Die Linke coalition that would support expansionary fiscal policies in Germany and the euro area. As a result, much less ECB support would be needed to stabilize economies.
• In Japan, limited fiscal and monetary easing is likely, irrespective of the election results.

Market Implications

• In the German elections, the base case scenario is negative EUR while the risk case is positive EUR.
• The outcome of the Japanese elections has more limited market implications and overall seems JPY neutral.

Japan and Germany’s Elections: No Direct Impact on ECB and BoJ Policies

Germany and Japan will hold lower house general elections on 26 September and before 28 November, respectively. Whatever the results, neither will likely impact monetary policy directly.

The election results could still impact monetary policies indirectly because of the mandate asymmetry between monetary and fiscal policies. While central banks have an explicit mandate to stabilize the economy, no such mandate is placed on fiscal policies. Consequently, monetary policy must offset any imbalance created by fiscal policy. In the US, for instance, the enormous fiscal stimulus enacted since the pandemic ($4.8tn or nearly a quarter of GDP) has led to inflation surging and monetary policy turning hawkish.

In neither country will fiscal policy likely provide the stimulus required to keep the recovery on track against a backdrop of slowing global growth.

German Elections Could Lead to Fiscal Policy Compromise

Coalitions have governed Germany since WWII, except 1957-61. This time, a coalition government is also likely (Chart 1).

Based on policy and ideologies compatibility, and current polling, the most likely coalition comprises the centre right CDU/CSU, the centre left SPD, and the Greens, locally known as the Kenya coalition (due to party colours, black-red-green), which would lead to roughly unchanged fiscal policy next year because the SPD would likely impose a policy compromise between the austerian CSU/CDU and fiscal activist Greens.

But the global economy is slowing and even unchanged fiscal policy may be insufficient to keep Germany’s recovery on track. Therefore, the ECB could well be compelled to ease further in 2022, for instance, by restarting the PEPP, currently scheduled to end in March 2022.

My risk scenario is an SDP, Greens, and Die Linke coalition that would bring about a policy mix with more fiscal and less monetary easing.

Limited Fiscal Easing Could Follow Japanese Elections

Contrasting Germany, the outcome of Japan’s elections is unlikely to impact much fiscal policy. The ruling LDP is well ahead of its rivals in the polls. The LDP has been in power since 1955, except during 1993-94 and 2009-12, and will probably remain in power this time too.

However, elections to the leadership of the LDP at end-September will precede the lower house elections, with the former the real electoral contest. Current Prime Minister Yoshihide Suga, whose popularity has been falling, will face several contenders including former Foreign Minister Fumio Kishida. Regardless, all candidates have expressed support for a new fiscal package as surging Covid infections have hit the economy. The package will likely be modest because Japan is already running a very large budget deficit. The BoJ could contribute to the policy easing, for instance, through a further expansion of its lending schemes.

Market Consequences

My base case German election scenario, a Kenya coalition, is negative for the EUR since it would involve unchanged fiscal policy and looser monetary policy. By contrast, my risk case, a red, red and green coalition, is EUR positive since it would involve renewed fiscal expansion and less monetary easing.

In Japan, I struggle to hold a strong conviction on the election’s market impact. Unlike in 2012 when Abe was first elected, there is no planned radical change in monetary or fiscal policies. I expect the combination of limited fiscal and monetary easing could be JPY neutral.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)