In the short term, investors hardly react to the AfD's victory in Saxony-Anhalt. That could change soon. Because Germany is under scrutiny, says Michael Maisch.
So far, German state elections have been a non-event internationally. But the AfD victory in Saxony-Anhalt is an earthquake that shook the political structures in the world's third largest economy so deeply that the media around the world reacted to it. For the US news agency Bloomberg, a kind of central organ for the capital markets, Germany has been a very dark place since Sunday evening and is running out of time.
Such pessimistic analyzes have so far had surprisingly little effect on stock prices and bond yields. The DAX is weakening and the yield on ten-year federal bonds remains at the high level from the beginning of September. But this probably has more to do with rising energy prices, the growing risk of inflation and the risk of further interest rate increases than with the resurgence of the far-right in German politics.
There are a number of plausible reasons for this lack of reaction immediately after the election. In the long term, however, the political turmoil in Germany could have an impact on the markets.
Economically, Saxony-Anhalt ranks lower with a share of just under two percent of German economic output, and its direct political influence is also limited.
The federal states do not have direct access to central elements of German economic, financial and foreign policy. These decisions are made at the federal level. Saxony-Anhalt only has four of 69 votes in the Bundesrat, which has to approve tax and social laws but has practically no influence on foreign policy.
But the election in Saxony-Anhalt is much more than a normal state election. The clear victory of the AfD endangers political stability at the federal level and could call into question Germany's role as an internationally reliable partner and an important member of the EU.
Investors will therefore pay very close attention to whether the SPD and the Union drift apart in their fight to continue to exist as popular parties and endanger the coalition. The first test will be the reform package. If Germany were to prove incapable of reform, this would likely have far-reaching effects, including the credit rating of the German state.
A look at Great Britain shows what the worst-case scenario looks like if investors withdraw their trust in a government. In 2022, the market for British government bonds was on the verge of collapse because the then new Prime Minister Liz Truss ignored the markets' concerns about stability with her budget policy. Truss was forced to resign after just 45 days in office.
Now there are big differences between the governments of Friedrich Merz and Liz Truss. On the one hand, Merz has been holding out for significantly longer than 45 days, and on the other hand, Germany's debt situation still looks much friendlier than that of the British.
But similar to the Conservatives under Truss, the Merz government is under probation. The coalition must prove that Germany can find its way out of its economic lethargy despite all the political turbulence. The next test comes with the elections in Berlin and Mecklenburg-Western Pomerania in a week and a half. After that, the market reaction could be much more lively.
