Merkel with Clipped Wings
By John R. Taylor, Jr.
The financial world seems totally nonplussed about the German election on Sunday. We agree that Angela Merkel will be the Chancellor once again, but we aren’t so sure about her freedom of movement on Monday morning, especially in the areas we care about: German policy on the euro and the manner in which Germany interacts with the other countries of the Eurozone concerning financial and structural issues. From our viewpoint, the crushing defeat of the Free Democrats (FDP) in Bavaria last weekend, where they polled only 3% – far below the 5% cut-off for parliamentary representation – was a bitter pill for Merkel, even though the CSU, the Bavarian branch of the CDU, polling over 47%, won a spectacular victory. Merkel is not running above 40% in the national polls and, even though that is not bad compared with the Social Democrats (SPD) around 26%, it will not put the CDU in power by itself. There must be a coalition partner, and with the FDP failing – at least, that is our forecast – Merkel will have to turn to the SPD once again. What makes this negative outcome more likely is the rapid growth of the country’s new euro-skeptic party, the Alternative for Germany party (AfD), which is taking votes from both the FDP and the CDU, weakening or dividing the right side of the political spectrum, just like the Left party has divided the left. With six parties scrambling for representation, a coalition is always a common outcome, but this coming coalition will be different than the last. The SPD is not the FDP and Merkel will have a hard time getting her way when it comes to her policies toward the southern deficit-ridden and recession prone economies. Even if the Socialist Party is made up of Germans, they are socialists and their voters are predominantly labor.
Their policies are more supportive of intervention and planning than Merkel’s, which has moved only when a crisis strikes. The SPD backs the Redemption Pact, leading eventually to a pooling of European debts, which had many supporters in the first half of 2012, before Draghi pulled the bumblebee out of his hat. To us this means that there will be increasing tension within the coalition as the SPD sees the next crisis developing. The SPD will push policies that help the whole of Europe far harder than the CDU would. What gives our picture of the future an exciting edge is its reality show overtone: Real Finance Ministers of Berlin. Remember that Peer Steinbrück was Merkel’s Finance Minister in the last grand coalition from 2005 to 2009 and that Wolfgang Schäuble is Merkel’s current Finance Minister. Neither of these are shrinking violets, and Schäuble has said that he plans to keep his job after the election, but Steinbrück’s history and strength is in exactly the same area. His stellar work strengthening German competitiveness fell into Schäuble’s lucky grasp. Steinbrück is not a raving socialist, as he is definitely on his party’s more conservative side, but he does see the need for education reform, infrastructure, and a strengthening of Eurozone and European coordination. Merkel has always been passive and slow to react to coming problems outside of Germany, within Europe, and the SPD will not sit quietly by while things unravel. Probably Steinbrück does not have the strength to win the battle against Merkel and Schäuble on his own, but it is extremely unlikely that his party will march meekly behind the CDU as the FDP has. Don’t expect any immediate change in Germany’s approach to Europe, but you must expect fireworks as soon as the next crack appears.
By John R. Taylor, Jr.
The financial world seems totally nonplussed about the German election on Sunday. We agree that Angela Merkel will be the Chancellor once again, but we aren’t so sure about her freedom of movement on Monday morning, especially in the areas we care about: German policy on the euro and the manner in which Germany interacts with the other countries of the Eurozone concerning financial and structural issues. From our viewpoint, the crushing defeat of the Free Democrats (FDP) in Bavaria last weekend, where they polled only 3% – far below the 5% cut-off for parliamentary representation – was a bitter pill for Merkel, even though the CSU, the Bavarian branch of the CDU, polling over 47%, won a spectacular victory. Merkel is not running above 40% in the national polls and, even though that is not bad compared with the Social Democrats (SPD) around 26%, it will not put the CDU in power by itself. There must be a coalition partner, and with the FDP failing – at least, that is our forecast – Merkel will have to turn to the SPD once again. What makes this negative outcome more likely is the rapid growth of the country’s new euro-skeptic party, the Alternative for Germany party (AfD), which is taking votes from both the FDP and the CDU, weakening or dividing the right side of the political spectrum, just like the Left party has divided the left. With six parties scrambling for representation, a coalition is always a common outcome, but this coming coalition will be different than the last. The SPD is not the FDP and Merkel will have a hard time getting her way when it comes to her policies toward the southern deficit-ridden and recession prone economies. Even if the Socialist Party is made up of Germans, they are socialists and their voters are predominantly labor.
Their policies are more supportive of intervention and planning than Merkel’s, which has moved only when a crisis strikes. The SPD backs the Redemption Pact, leading eventually to a pooling of European debts, which had many supporters in the first half of 2012, before Draghi pulled the bumblebee out of his hat. To us this means that there will be increasing tension within the coalition as the SPD sees the next crisis developing. The SPD will push policies that help the whole of Europe far harder than the CDU would. What gives our picture of the future an exciting edge is its reality show overtone: Real Finance Ministers of Berlin. Remember that Peer Steinbrück was Merkel’s Finance Minister in the last grand coalition from 2005 to 2009 and that Wolfgang Schäuble is Merkel’s current Finance Minister. Neither of these are shrinking violets, and Schäuble has said that he plans to keep his job after the election, but Steinbrück’s history and strength is in exactly the same area. His stellar work strengthening German competitiveness fell into Schäuble’s lucky grasp. Steinbrück is not a raving socialist, as he is definitely on his party’s more conservative side, but he does see the need for education reform, infrastructure, and a strengthening of Eurozone and European coordination. Merkel has always been passive and slow to react to coming problems outside of Germany, within Europe, and the SPD will not sit quietly by while things unravel. Probably Steinbrück does not have the strength to win the battle against Merkel and Schäuble on his own, but it is extremely unlikely that his party will march meekly behind the CDU as the FDP has. Don’t expect any immediate change in Germany’s approach to Europe, but you must expect fireworks as soon as the next crack appears.
Battle of the Central Banks
By Jonathan Clark
The economic policies of Prime Minister Shinzô Abe, collectively termed ‘Abenomics’, increased consumer optimism and paid early dividends in economic terms, but their impact is starting to fade. After growing 1.0% in Q1 and 0.9% in Q2, forecasts call for Japanese GDP to slow during the second half of the year. Consumer confidence climbed from 39.9 in December of last year to 45.7 in May, before falling back to 43.0 in August. Mr. Abe is expected to announce by October 2 that the sales tax will be allowed to increase from 5% currently to 8% next April, but he is also expected to announce a stimulus package to businesses and consumers to counteract the effects of higher taxes. The major impact to growth of Abenomics appears to be behind us and that leaves the Bank of Japan to do the heavy lifting of stimulating the economy. On April 4, Bank of Japan Governor Kuroda announced a massive quantitative and qualitative monetary easing program (QQE) to inject $1.4 trillion into the economy in less than two years. The monetary base would nearly double to ¥270 trillion by the end of next year in a step intended to achieve the BoJ’s 2% inflation target. The BoJ committed to buying ¥7.5 trillion of long-term government bonds per month, which is more than the Ministry of Finance is currently issuing, and should ensure that JGB yields remain relatively low.
In the battle of central banks, the Federal Reserve hit the canvas on Wednesday when it failed to meet market expectations and taper asset purchases. As the chart clearly shows, this caused US interest rates to fall versus those in Japan and as a result dollar/yen declined. The BoJ won this round, but the fight is far from over as we expect US interest rates to rise versus Japanese interest rates over time and this will support the dollar/yen. Except for during the three weeks following May 22 (the date that Fed Chairman Bernanke’s stated that the pace of bond purchases could be tapered within the next few meetings of FOMC, provided the economic recovery continues), the widening short-term interest rate differential between the US and Japan has been positive for dollar/yen. This recent setback is unlikely to persist for long, but it should take up to several weeks before dollar/yen resumes its major uptrend. Our strategy is to buy dollar/yen on weakness. According to the cycles, the most likely time for a low in USD/JPY is the week of September 30, but we are not expecting an aggressive decline and we doubt it will fall below 96.25 and it might not even prove that weak. Following this low, dollar/yen should turn higher and resume its uptrend. A close above the resistance at 100.10 will signal that the uptrend has resumed into early January and our target for this upmove will become the 106.00 area.
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