Germany's Political Shift: How a Far-Right Victory Could Reshape European Markets

Could the rise of Germany's far-right AfD destabilize European markets and shake investor confidence ahead of the 2025 elections?

(Picture: Rasmus Gundorff Sæderup, Unsplash)

Background

• Germany is witnessing a significant shift in its political landscape as the far-right Alternative for Germany (AfD) party gains momentum.

• Recently, the AfD secured a historic victory in the Thuringia state parliament election, winning nearly a third of the vote, and almost overtook the conservative CDU in Saxony.

• This surge in support highlights growing discontent with the current government, particularly regarding issues like immigration, economic challenges and Germany's role in supporting Ukraine.

• With the federal elections approaching in 2025, there is a realistic possibility that the AfD could play a significant role in the next German government, either directly or by influencing mainstream parties' policies.

Are Immediate Stock Market Reactions Nervous?

The rise of the AfD, with its anti-EU and anti-immigration rhetoric, is likely to cause heightened volatility in both German and European stock markets. The DAX, Germany's primary stock index, lost almost 2% between September 2 and 4 and could experience further declines due to fears of political instability, potential economic isolationism and concerns about the AfD's economic policies, which may prioritize national interests over EU integration. This decline occurred even though the AfD cannot govern in Thuringia.

Conclusion: Yes, markets tend to react nervously to immediate shocks. The DAX lost 2% following recent election outcomes in Thuringia and Saxony, where the AfD cannot even form a government.

Will the DAX and European Indices Suffer if the AfD Comes to Power in 2025?

Should the AfD come to power or heavily influence the government in 2025, the DAX could face prolonged periods of underperformance relative to other European indices, particularly if their policies lead to economic isolation or conflicts within the EU and global trade. Broader European indices, such as the Euro Stoxx 50, might also be negatively impacted due to the ripple effects of political and economic uncertainty in Germany, Europe's largest economy. Markets might price in the risk of a fracturing EU, leading to a cautious investment climate across the continent.

Conclusion: Yes, it could lead to substantial underperformance for the DAX and other European indices due to increased economic and political uncertainty, which might drive cautious investment behaviour.

What Could Happen to Bond Markets?

If the AfD gains power or there's significant threat of political instability, investors might worry about the long-term economic outlook for Germany. This concern can lead to higher yields on German government bonds because:

• Higher Risk Premiums: Investors may demand higher returns (higher yields) for holding German bonds due to perceived increased risk from potential political instability.

• Selling Pressure: Some investors might sell off German bonds out of fear, which could push bond prices down and yields up (since yields move inversely to prices).

As a result, German bonds may no longer be seen as a secure investment. Instead, investors might turn to bonds from traditionally safer countries like the U.S. or Switzerland. As more investors buy U.S. or Swiss bonds, their prices would rise, and their yields would decrease.

Conclusion: German bonds may see increased yields due to higher perceived risk and potential selloffs. Conversely, bonds from traditionally safer countries like the U.S. or Switzerland might attract more investors, leading to lower yields on these bonds as their prices rise.

What Industries and Economic Sectors Might Be Most Affected?

The AfD's policy program could have wide-ranging effects across various industries due to potential changes in EU relations, economic policies and immigration controls. Here are several sectors that might experience significant impacts:

Energy Sector

The AfD’s potential shift towards traditional energy sources could significantly impact the energy sector. If the party favours coal and natural gas over renewables, traditional energy companies might see short-term gains. However, this could lead to reduced investment in green technologies, potentially affecting the long-term growth and sustainability of the renewable energy sector.

Automobile Industry

The automobile industry might be significantly affected by the AfD’s policies, especially if there are shifts in environmental regulations or trade policies. Companies focusing on electric vehicles might face uncertainty if the AfD rolls back green initiatives, while traditional auto manufacturers could benefit from reduced regulatory pressures and AfD support for diesel. Protectionist measures or trade disruptions could impact global supply chains and market access for German car manufacturers.

Construction and Real Estate

Tighter immigration controls could impact the construction and real estate sectors. Many construction workers in Germany are immigrants, and stricter immigration policies might lead to labour shortages, affecting project timelines and costs. Additionally, shifts in housing policy influenced by the AfD could alter market dynamics, impacting real estate prices and development projects.

Finance and Banking

The financial sector could face increased volatility and uncertainty if the AfD’s policies lead to economic isolation or instability within the Eurozone. Banks and financial institutions might experience heightened risk premiums and fluctuations in investment inflows. Uncertainty about Germany's role in the EU could also affect cross-border financial transactions and investments.

Conclusion: The AfD's policy program is likely to have significant and varied impacts across key industries such as energy, automobiles, construction and finance. The overall effect on these sectors will largely depend on the specifics of the AfD’s policies and their broader economic implications.

What Should You Do as an Investor?

Currently, the AfD has only won in Thuringia and placed second in Saxony, meaning they do not have the power to form a government either in these Bundesländer or at the federal level. At this stage, it’s crucial not to overreact but to closely monitor news and opinion polls for any shifts in AfD popularity leading up to the 2025 elections.

If the AfD gains a significant role in the next German government, either directly or through influencing mainstream parties’ policies, consider the following strategies:

• Immediate stock market reactions: Experienced day traders might capitalize on short-term price swings resulting from immediate election reactions. Quick trades could be profitable if you accurately predict market movements based on news and events.

• Mid-term index strategies: Diversify your investments to include other “hedging” indices or assets that may be less affected by German political developments. This can help mitigate risk if the DAX becomes highly unpredictable.

• Bond strategies: If German bond yields increase due to political instability, you may choose to invest in these higher-yield bonds if you’re comfortable with the associated risk. Alternatively, for more stability, consider Swiss or U.S. bonds, which could offer a safer investment.

• Sector strategies: You might want to increase your positions in sectors likely to benefit from AfD policies, such as traditional energy companies (coal and gas) and traditional automobile manufacturers.

By staying informed and strategically adjusting your investment approach, you can better navigate the potential impacts of the AfD's evolving role in German politics.