Edward Harrison is the founder of the blog Credit Writedowns and is a finance specialist at Global Macro Advisors. Previously, Edward was a strategy and finance executive at Deutsche Bank, Bain, and Yahoo. He started his career as a diplomat and speaks German, Dutch, Swedish, Spanish and French. Edward holds an MBA from Columbia University and a BA in Economics from Dartmouth College.
Germany held elections in Nordrhein-Westfalen (NRW) this past weekend. And the results, while encouraging for Angela Merkel’s CDU, point to difficulties that lie ahead for French President Emmanuel Macron’s reform agenda in Europe. This is negative for periphery bonds.
German politics. First are the politics in Germany. Macron’s natural allies in Germany are the SPD. And they had a tough time connecting with voters under former head Sigmar Gabriel, the German foreign minister. So he stepped down and let Martin Schulz, a man with a common tough who had been President of the European Parliament. There was a so-called ‘Schulz Effect’ that saw the SPD polling well when the change was made earlier in the year.
But, because Schulz is no longer in government, he has been less visible in the German media and all of that initial euphoria has faded. The result of the Schulz Effect fading is three regional election losses for the SPD, the most devastating of which was last Sunday in Nordrhein-Westfalen, an SPD stronghold and Germany’s largest state, home to one in five Germans.
Not only did the SPD cede power in NRW, there were massive losses for them and their coalition partner, the Green Party, which translated directly to gains for Merkel’s CDU and the free-market FDP. In fact, it is the FDP high-water mark of 12.6% in NRW that matters most here because it makes a CDU-FDP national coalition thinkable for the first time since 1998.
Macron needs to worry. This isn’t favourable to Macron’s getting German conciliation on European issues at all. Where the SPD has embraced his agenda and the CDU is sceptical, the FDP is downright hostile. A German government controlled by the CDU and the FDP would effectively end Macron’s dream of transforming Europe.
Merkel and Macron. Now, Merkel is a cautious politician. She is considered a safe set of hands. And while she welcomed Macron to Berlin on Monday, she had little of substance to say regarding support for a European reform agenda. And that’s to be expected given the upcoming election. But once the coalition is set in September, Merkel will decide what Germany’s position is on reforming Europe. With the SPD in tow, she will be more receptive to reform. With the FDP, she will be much less receptive. Either way, Europe has a long road to hoe and I don’t rate Macron’s chances highly in the medium term.
Bottom line: As all of this becomes apparent, bond markets will begin to react because default and redenomination risk will increase in the Eurozone periphery. The weakest link in Europe is Italy. If you look at economic growth there, there has been none for two decades. On a purchasing power parity basis, Italy is back to where it was in the 1990s. That’s worse than Greece.
ITALY: GDP per capita at PPP is lower today than when euro was formed.
WORSE THAN GREECE.
Weak link in eurozone pic.twitter.com/QzDTExcmSk
— Edward Harrison (@edwardnh) May 16, 2017