September 27, 2017— On Sunday, Germany held general elections for the Bundestag, its lower house of parliament. This election was the last in a series of 2017 European elections in which right-wing, anti-immigrant parties and candidates challenged centrists. Earlier this year, centrists soundly defeated extremists in both the Netherlands and France. In the campaign for German elections, yet another extremist right-wing party, the Alternative for Germany, posed a serious challenge to Chancellor Angela Merkel’s Christian Democratic Party. The Alternative for Germany’s third-place finish has forced Merkel to seek new coalition partners in smaller parties. We examine what happened on Sunday, why it happened, and what we expect going forward.

What happened?

  • Chancellor Angela Merkel’s center-right Christian Democrats placed first, winning one-third of Bundestag seats.
  • Martin Schulz’s center-left Social Democrats placed second, winning one-fifth of Bundestag seats.
  • Both parties lost votes to the neo-fascist, anti-immigrant Alternative for Germany, which won 12.6% of the vote. The Alternative performed particularly well in poorer eastern Germany.
  • Both parties also lost votes to the pro-business Free Democrats, which won 10.7%.
  • The Social Democrats have decided to exit their longstanding coalition with the Christian Democrats and lead the Bundestag opposition
  • The Social Democrats’ departure from the coalition forces the Christian Democrats to woo the Free Democrats and Greens as coalition partners.
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Source: Federal Returning Office, Germany’s official elections certifications commission

Why did the Christian Democrats and Social Democrats lose seats?

  • Chancellor Merkel’s decision to admit almost a million Mediterranean migrants undermined her personal popularity and boosted support for the Alternative for Germany.
  • Russia undertook an active disinformation campaign to undermine Merkel.
  • Some centrist voters simply saw the need for fresh leadership, and decided to switch their votes from the Merkel/Schulz coalition to the Free Democrats.
  • The Social Democrats attribute their loss of seats to the dilution their center-left brand identity within the Merkel-led coalition. By entering opposition, they see an opportunity to refresh their brand and rebuild their base.

Do we expect a three-party coalition government?

  • Although it may take months of negotiations, we expect that the Christian Democrats will be able to form a coalition with the Free Democrats and Greens.
  • The pro-business Free Democrats have been in coalition with the Christian Democrats at many times in the past, so their participation is all but assured. They hope to fill ministerial positions relating to trade, regulation, information technology, and/or migration. In particular, they hope to have some influence with respect to limiting or rolling back those European Commission regulations that intrude on business.
  • The Greens have been in coalition with Christian Democrats at the state level, but not yet at the Federal level. We expect that the Greens will condition their participation on filling ministerial positions relating to the environment and renewable energy. The Greens will likely also require an accelerated closure of coal-fired power plants.
  • We expect that the Christian Democrats will continue to control major policy portfolios relating to fiscal policy, foreign affairs, and defense. We expect no change in Germany’s pro-U.S., pro-NATO orientation.

Will Chancellor Merkel resign?

  • The chancellor has not publicly indicated her intentions. Nevertheless, given that she has accepted that her actions led to the large loss of seats, it seems likely that she will resign leadership of the Christian Democrats, and thus of the chancellorship itself.
  • Although such resignation will most likely occur after Bundestag approval of the coalition, Merkel may already be signaling to the Free Democrats and Greens that she plans to resign after Bundestag approval. This would likely facilitate formation of the coalition.
  • We would expect that any new Chancellor will be one whose views are aligned with the views of the new coalition partners and is well-respected in EU and NATO circles.

Will Alternative for Germany enter government or lead the opposition?

  • All German political parties reject working with the Alternative for Germany.
  • Should Merkel resign, Alternative for Germany would lose its main demon, thereby deflating its sails.
  • The decision of the Social Democrats to enter opposition denies Alternative for Germany the prominent role of opposition leadership, keeping them in a marginal role.

What policy changes do we expect?

  • Somewhat greater structure to migration and citizenship policies.
  • Greater limitations on regulatory actions by the European Commission.
  • A more cautious approach to the consolidation of EU authority in Brussels.
  • A more flexible approach to negotiations with the UK over Brexit.
  • Faster moves on adoption of renewable energy and environmental protections.

Core narrative 

Currently, we are overweight international developed market equities. European political stability is one of the critical factors for our investment views.  

Sunday’s election may produce a multi-party coalition. This is typical for Germany and many continental European countries. The extreme right and left parties, though now represented in the Bundestag, will most likely play no role in government, nor will they formally lead the opposition. We expect the only change is that the pro-business Free Democrats and Greens will replace the Social Democrats as ‎junior coalition partners for Chancellor Merkel.  

Changes to Germany’s policies will be minor, but probably, on the whole, mildly beneficial, and do not change our fundamental views regarding European political stability.  

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