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Euro struggling to maintain boost from German election.
John J. Hardy
Global Head of Macro Strategy
Résumé: The euro rallied on the German election result, but is struggling to maintain altitude as so many questions loom for both Germany and Europe on both the will and ability to deliver dramatic fiscal expansion.
German election: worst outcomes for EUR avoided, but path to fiscal expansion remains uncertain.
The German election avoided both the “nightmare” and “double nightmare” scenarios I outlined last week, if only by the narrowest of margins. The headline is “relief” because the CDU/CSU bloc will be able to form a government if it can get the SPD on side, which is likely if difficult as the two parties disagree on many issues. This avoids the CDU/CSU having to seek help from the Greens in what would have been an even more awkward three-way coalition. Often, forming coalitions can take several months, but CDU leader Merz, who will be the next Chancellor, has declared a desire to form a government within two months – the urgency is clear.
Merz said after the election results were emerging that Germany will "achieve independence" from the US as President Donald Trump is "largely indifferent to the fate of Europe". We can expect that the Trump administration’s policy toward Europe will be one of maximum retaliation if Europe decides it wants to go its own way and doesn’t want to sign up for a US-centric “Grand Macro Strategy” as Michael Every calls it, which would only be about extending the EU friendly terms if the EU services US national economic security imperatives. We’re still waiting for Trump’s threatened tariffs on the EU - will the EU side allow itself to be bullied on trade policy with the US and for example to change its Digital Markets Act and Digital Services Act, which target US internet monopolies?
Outside the trade policy showdown and partially related status of that issue with the commitment of the US security umbrella, the most pressing questions for Germany and for Europe are on the fiscal front. Merz has acknowledged the need for more investment in infrastructure in Germany and the EU and Europe’s desperate under-investment in defense capabilities are painfully clear, especially should NATO partially or fully collapse. But to get on the road to a massive fiscal expansion is not in Germany’s traditional mindset outside of emergencies like the pandemic. The new leadership will have to dance around “debt-brake” rules to even unlock budget deficits beyond 0.35% of GDP because the parties likely to support overturning the debt-break don’t have two-thirds majority. Two ways it could do so are supposedly via “off-budget” funds for investments or declarations of emergency, so it can be done, but can it be done at scale with an awkward center-left-center-right coalition. Equally, at the EU level, the talk is of a large fiscal expansion of EU-issued euro bonds to build more credible “hard power” as Sir Alex Younger calls it, to defend Europe. Can this most bureaucratic of institutions move at anything resembling speed and make efficient and productive investments in more credible defensive capabilities? For a significant and secular move higher in the euro, both German- and EU fiscal cylinders will need to fire in unison.
The EU will convene a “special summit” on March 6.
The German election details if interested: Of the centrist parties, the FDP collapsed by failing to clear the 5% threshold for representation in the Bundestag, the CDU/CSU bloc underperformed the polls a bit with 28.5% of the vote (29-30% in polling), the SPD was in-line with expectations at 16.1% and the Greens stumbled worse than expected to a 11.6% result. Beyond the centrist parties, the right-populist AfD performed at the strong end of pre-election polling and got 20.8% of the vote and has promised to be a loud opposition party to the government. The leftist BSW, with 4.97%(!) just missed the 5% threshold, which was the key development opening the door for a CDU/CSU government with the SPD. The other leftist Die Linke polled strongly with nearly 9% of the vote.
Chart: EURUSD
EURUSD mounted a challenge at the range high and high for 2025 at 1.0533, but failed to do so and has now erased its positive reaction to the German election, although risk sentiment in equities in Europe today is happy with the outcome (some relief on avoiding the most awkward of coalitions, perhaps). Until we get a firmer signal from Europe on how Germany plans to get around its own debt-brake rules as outlined above and we see a committed EU-level plan to build a more robust defense, the euro may continue to languish against the other major currencies. Risk of a steeper sell-off if the selling takes out the recent 1.0401 low, possibly opening for 1.0200 again, with strong close above 1.0500 needed to keep the focus higher.
JPY shows teeth again after roller coaster Friday
Friday saw a roller coaster ride for yen traders, as the Bank of Japan came out after another hot inflation report to indicate its dislike for the steep rise in Japanese government bond yields. This saw a steep backup in JPY crosses. Then, the US session showed once again that the center of the universe for JPY traders is the US 10-year yield, which dropped sharply late Friday on one of the uglier bouts of selling in risk assets in recent months. This pumped the JPY right back to its highs of the cycle and saw USDJPY challenging below 149.00 both on Friday and overnight, although we are back to risk-on this morning in Europe for stocks if not for the euro on the German election outcome. The next key chart point in USDJPY is the range low from last October of 148.65. I asked last Monday whether BoJ policy and yen policy generally might be as much a question of geopolitics (avoiding negative attention from the Trump administration) as a question merely of managing inflation risks. The BoJ rhetoric on intervening in the bond market doesn’t do much to support the geopolitical angle for now, though I still suspect it weighs in the Japanese government’s minds.
The week ahead
The macro calendar this week is very light this week, theoretically topped by the ancient history that is the December PCE inflation number out on Friday. Market commentators are pointing out rightly that US general sentiment indicators like Friday’s final February University of Michigan sentiment survey numbers, are useless as they are nothing more than political polls for the respondents in a super-charged partisan politics landscape. Republican respondents think things are fantastic and inflation is set to collapse on all time frames, while Democrats fear for an inflationary end of the world. So don’t count on much enlightenment from the Conference Board Consumer Confidence numbers up tomorrow.
Still, I am looking for increasing evidence of a weaker US economy in the months ahead as the disruption of US government agencies from the blitz of Trump’s executive orders and Musk’s DOGE begin to weigh and as the fiscal drag sets in after the Biden administration’s fiscal push to juice the economy ahead of the November election.
Risk sentiment watch
The Wall Street Journal is out with an article this morning (also available on the English news section on the Saxo platform: “The US Economy Depends More Than Ever on Rich People”) noting exactly what is in the title, that the wealthiest 10% of Americans are driving 50% of US spending, feeling not only confident due to their strong incomes, but especially due to the status of their investment portfolios. On that note, if Friday’s ugly stumble in risk assets is the sign of a more sustained retrenchment, or even a bear market, the “reverse wealth effect” could double down on the risks to the US economy as the wealthy elite tighten their purse strings. This week is particularly important for stocks as Nvidia is set to report its earnings on Wednesday after the market close. The company is at the core of the AI phenomenon – many would say bubble – and is a single stock that can either shore up sentiment or destroy it, depending on whether it surprises positively or negatively. Last Friday, Microsoft CEO Satya Nadella said that there is an “overbuild” in AI systems… if Nvidia comes close to confirming this or indicating faltering momentum, risk assets could be in for a rough ride – generally favouring the JPY and even the US dollar, if less so.
NEW FX Board of G10 and CNH trend evolution and strength.
Note: Rather than provide the usual note – I have created a video tutorial for understanding and using the FX Board.
Few changes in recent trends – a key question for this week is whether the USD establishes a more widespread down-trend, with EURUSD outlook critical there.
Table: NEW FX Board Trend Scoreboard for individual pairs.
EURCHF risks slipping into a bear trend if it posts a new low in coming sessions and is perhaps one barometer of sentiment on the prospects for an EU fiscal expansion. Elsewhere AUDNZD has reversed back deep into the range and looks to flip to a negative trend if it continues lower, although a long-term sticky range there that stretches back months.