Major reshuffle in German political arena will the new government bring new hope to the European market?

Notice that the restructuring of the German government may bring a glimmer of hope to the weak economy of the Eurozone, as potential increased spending could support the Euro and stock markets, although the future direction is still uncertain. The market has already started anticipating that the government will increase borrowing to stimulate the economy, pushing the closely watched bond market debt issuance indicators to record levels. One reason for the collapse of the ruling coalition is differences over whether to suspend the German debt brake, and the initial market interpretation is that the new elections in February could bring more certainty to the German economy, which has just avoided a recession. After news of the collapse of the German government last Wednesday, the German stock market outperformed its European peers, another sign that a more positive sentiment is prevailing--but on the same day, Trump won the US election, triggering threats of tariffs on the largest economy in Europe. "The weak growth of the German economy is largely self-inflicted because Germany still insists on the debt brake despite the need for economic support," said Guy Miller, chief market strategist at Zurich Insurance Group. "The collapse of the coalition government is constructive, and we hope that the budget for 2025 will have more fiscal flexibility." Debt brake dilemma Economists have long blamed the debt brake implemented in 2009 for dragging down the German economy, with a contraction expected this year. Kasten Bulesinski, global head of macroeconomics at ING, estimates that increasing government spending by 1% to 2% over the next 10 years could raise the potential growth rate from the current 0.5% to at least 1%. "Germany doesn't have any public fiscal problems," Brescinski said, as debt accounts for only 63% of output, giving it more spending space than peers such as France and Italy. "If you can combine reforms with a more relaxed fiscal policy, please do so," he added. The International Monetary Fund (IMF) has also suggested that Germany should consider relaxing debt constraints, as any signs of increased spending could boost European stock markets. The pan-European Stoxx 600 index has only risen 6% this year, less than a quarter of the 26% rise in the US S&P 500 index. Barclays believes that hopes for a shift in policy towards supporting growth will "very much require a reassessment of German stock valuations." Citi expects that the conservative opposition party, the Christian Democratic Party, which leads in opinion polls, will propose tax cuts to support the stock market. The euro fell to its lowest level since April on Tuesday, dropping to about $1.06, as rumors of tariff concerns reignited, but the euro could also benefit. Kit Juckes, chief foreign exchange strategist at Industrial Bank of France, noted that Germany has overtaken Japan this year as the country with the most foreign assets, meaning it has ample capital to invest in its own economy. These funds "can be used to purchase high-yield German bonds to drive economic development," Juckes said, adding that if the German government hints at a significant change in its policy direction, this could ultimately have a "significant impact" on the euro. Hopes for a change in German policy could also open the door to more joint spending in Europe. Trump's election may require the EU to increase defense spending, as the group is already facing calls for large-scale investment to boost competitiveness. Gilles Guibout, head of European equity strategy at Axa Investment Managers, said, "A change in tone from the German leadership is crucial to further European integration." He called the dismissal of Finance Minister Christian Lindner "good news for Europe," but added that whether this is enough remains to be seen. Lindner is a fiscal hawk. Of course, political uncertainty means that industries will be more painful in the short term and could potentially harm market sentiment. The conservative party expected to lead the next government may limit the growth rate of spending. Opposition leader Mertz of the Christian Democratic Union wants to stick to the debt brake. To discuss reforms, he wants to see suitable conditions for investment in growth-promoting projects, while also controlling welfare spending. He also opposes further increases in EU common debt. Economists are debating whether the debt brake itself can drive reforms, or whether Germany can initiate new off-budget spending, which would require majority support in parliament. Goldman Sachs expects the conservative party to only support modifications to the debt brake to moderately increase spending, around 0.5% of output, and expects fiscal policy to continue to "drag down" economic growth. Mackenzie strategist Thierry Wizman suggests shorting the euro in the absence of a reformist government. For others, the change is just a matter of time. Davide Oneglia of consulting firm TS Lombard expects that early elections will make the debate about Germany's growth model and EU security risks "urgent." He said, "We believe the main risk is that they fail to grasp the necessity of a paradigm shift and revert to an old economic model that is no longer feasible. By then, the German and EU economies will face a more severe reckoning."