Status quo in Germany points to strong euro


German Chancellor Angela Merkel’s Christian Democratic Union and its sister party, the Christian Social Union, have handily won more than 42% of the vote in the parliamentary elections. This means Angela Merkel has a strong endorsement from her party and the German public to continue pushing for budget consolidation and structural reforms in the eurozone.

Budget consolidation is simply shorthand for either increasing government revenues or decreasing government spending (or, at least, the growth rates of both). Structural reform is shorthand for a hodge-podge of policies to open up domestic markets to more competition and other less well-defined policies. That’s one of the problems with the changes in the eurozone: Nobody really knows what the end goal is. Some countries view protecting domestic firms or culture as sacrosanct while others view those same policies as needing reform.

Although the eurozone governments may never agree on what budget consolidation or structural reforms are enough, the biggest proponent of eurozone unity—Angela Merkel—has a renewed mandate to push forward to an ill-defined goal for an indefinite period.

European Central Bank (ECB) President Mario Draghi famously said he would do whatever it takes to keep the eurozone together—with the big caveat of having it be within the ECB’s mandate of stable inflation. But the ECB has yet to put its money where his mouth was. I doubt any of the ECB’s programs or policies will lead the ECB to embark on large-scale asset purchases like the U.S. Federal Reserve and the Bank of Japan have undertaken. As a result, we may see continued strength in the euro in the foreign exchange market. While a dramatic depreciation of the euro would help the uncompetitive countries—like Greece, Portugal, and even France—it’s unlikely to come anytime soon. Thus, it will likely be business as usual in the eurozone for the next year or so.

For investors, I think this means that there is little risk of euro weakness offsetting equity or fixed-income market gains.

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