Investors are on standby for Europe’s own version of the Trumpflation trade in case Wolfgang Schaeuble’s successor at the German finance ministry directs the country’s massive surpluses towards tax cuts and spending.
Germany has run up budget surpluses in recent years under Schaeuble’s watch, but market participants believe a more expansionary policy may follow last month’s elections, particularly if the pro-business FDP party are part of a new government as expected.
Though the FDP — the Free Democratic Party — are, like Schaeuble, considered fiscal hawks, their manifesto included a proposal for 30 billion euros ($35 billion) of tax cuts.
There are political doubts about whether they will get their way, but recent record surpluses do mean that Germany has room for manoeuvre.
German economic institutes forecast record surpluses in the next two years and say that the government should use the extra fiscal room to lower income tax and social welfare contributions.
Any such measures could trigger a “reflation” trade similar to the one many investors put on in the United States after Donald Trump was elected and expectations rose he would introduce inflation-boosting tax cuts and fiscal spending.
“I expect that in a new coalition, the Greens will be rewarded with higher public expenses and the (FDP) with a cut in taxes,” said Patrick Barbe, chief investment officer of core fixed income at BNP Paribas Asset Management, referring to two of the three parties likely to be part of the new German government.
BNP Paribas AM has 566 billion euros of assets under management, and is one of the largest buyers of bonds in Europe.
“And if you have tax cuts in Germany, it should be positive for reflation assets,” he said.
Apart from stocks, which are the obvious port of call in a reflationary environment, he pointed to inflation-linked bonds and real-estate assets as two areas he has earmarked for investment in case this comes to pass.
Last week’s German election saw Chancellor Angela Merkel win a fourth term, but support for her conservatives slumped to its lowest since 1949.
The likeliest news government is a so-called “Jamaica” coalition, named for the Jamaican flag’s colours: black for Merkel’s Christian Democrats (CDU) and their Christian Social Union (CSU) Bavarian sister party; green for the Greens; and yellow for the FDP.
There is no clear frontrunner to succeed Schaeuble. FDP leader Christian Lindner was seen as a potential replacement, but has signalled he would rather lead the party in parliament, possibly opening the door for his deputy, Wolfgang Kubicki.
Furthemore the FDP, however, is far from profligate. Even with the 30 billion euro tax cut proposal — which would be subject to Jamaica talks agreements — the party remains committed to “Schwarze Null”, a federal budget in the black.
Many investors, however, are expecting a loosening of budget strings.
Markus Schomer, chief global economist at Pinebridge, which has over $85 billion of assets under management, estimated there could be 30 billion euros of tax cuts and 10-20 billion euros more spending under a Jamaica coalition.
“There’s potential in our multi-asset portfolio to add some more European assets as a result. We don’t have much exposure now,” he said.
Pinebridge expects the German economy to grow 2.2 percent growth in 2018 and 2019 but this expenditure could add another 20 basis points to that, he added.
On Schaeuble’s watch, Germany has been one of the few countries in Europe to consistently run a budget surplus – so much so that the European Commission criticised Europe’s largest economy for not loosening its purse strings.
“If Germany had taken reflationary action sooner… this would have provided external demand support for ‘peripheral’ countries which would have seen higher GDP growth and by consequence lower budget deficits,” said Willem Verhagen, an economist at Dutch fund NN Investment Partners, which has 199 billion euros of assets under management.
A 0.5 percentage point increase in the structural deficit will increase German domestic demand and the German inflation rate, he said.
German consumer prices rose less than expected in September and at 1.8 percent, inflation remained below the ECB’s target.
One thing that is unlikely to change with Schaeuble’s departure, meanwhile, is German dislike for loose monetary policy.
There would be no let up under the FDP on pressure for the European Central Bank to roll back its stimulus.
Source: Reuters (Reporting by Abhinav Ramnarayan, Graphics by Ritvik Carvalho Editing by Jeremy Gaunt)