Markets between geopolitical uncertainty and reform

Can Germany do reforms after all?

The early exit of Germany’s national football team from the World Cup in North America is a fitting image for the German economy. It, too, has seen better days. It is not only Paraguay – whose team sent Germany packing – that has grown faster than the Federal Republic over the past five years. In fact, more than 92% of countries worldwide have done so. At the start of the year, Germany still looked poised for an upswing: incoming orders delivered positive surprises, and expansionary fiscal policy stimulated demand. Then came Gulf War 3.0, launched without any discernible strategy, and landed like a two-footed tackle in the penalty area. Donald Trump really ought to see red for that. But, of course, real life this side of metaphor does not work that way.

This time last year, the trade war threatened by the U.S. was perhaps the biggest worry for Germany’s export-dependent economy. That danger has not gone away. But it has now been joined by an actual hot war, one that is weighing on global demand and pushing up prices – and not only because energy has become more expensive. The adversaries are currently negotiating, and hopes of a lasting solution are buoying markets. Investors are already selling the bear’s skin before it has been killed. Iran and the U.S., after all, once again seem to be interpreting the course of the talks rather differently. Tehran believes it has the stronger hand in the negotiations. And there is something to that. Genuine peace is therefore anything but assured.

For central banks, the message is clear: discretion is the better part of valor. After the recent bout of inflation, monetary guardians cannot afford to let price stability slip again. Even under Kevin Warsh’s new leadership, Trump’s demand that the Fed slash rates, will not be fulfilled. And after the ECB’s first rate increase, another is likely to follow. Long-term rates, too, are more likely to trend upward. Wherever one looks, governments are indulging in a debt binge. Even Germany, once the keeper of the seal of fiscal restraint, is likely to run general-government deficits of around 4% of GDP in the years ahead. The resulting higher long-term rates are hardly likely to give private-sector investment much lift.

For equity markets, higher rates are an additional burden on top of valuations that are already rather stretched. Accordingly, June brought the first setbacks, despite the supposed easing of tensions in the Persian Gulf. Shareholders have, as it were, been shown a yellow card – one that may prompt them to play a less aggressive game.

In Germany, all eyes are now fixed expectantly on a “summer of reforms” – a phrase that echoes the country’s 2006 World Cup “summer fairy tale.” Suddenly, the government is showing attacking intent. The ball is on the penalty spot. The coalition now has to hold its nerve. If it misses, the mood will turn sour for good. Failure is not an option!