Impact Of Angela Merkel’s Resignation Announcement On The Euro

On 29 October 2018, German Chancellor Angela Merkel issued a surprise statement of resignation from political life. During a public address in Berlin, Merkel relinquished leadership of the Christian Democratic Union (CDU), the political party she chaired since 2000. The position of chancellor also came into question as Merkel committed to not seek reelection upon the conclusion of her fourth term in 2021. Both statements effectively ended Merkel's political career, prompting uncertainty as to the future of both German and European Union (EU) leadership.

In the wake of Brexit negotiations and the U.K.'s transition out of the EU, the upheaval in German politics brought immediate volatility to the euro (EUR). In the hours following Merkel's announcement, the EUR fell against the United States dollar (USD) amid extremely turbulent forex conditions.^[1] As the long-term impact of Merkel's resignation was digested by the markets, indecisive trading plagued the EUR against the majors throughout subsequent forex sessions.

Merkel stepping down as the leader of Europe's largest single nation economy injected fresh uncertainty into EU economics. The sudden political instability prompted traders and investors to reevaluate the future of the eurozone as well as the challenges facing the EUR itself.

Terms Of Resignation

Periodically touted as being one of the "most powerful people in the world,"^[2] Merkel led Germany for 13 years, beginning in 2005. The 29 October 2018 announcement by the physicist-turned-politician came as a surprise to many, with the official statement being multifaceted:^[3]

• Resignation As CDU Leader: Merkel's statement outlined plans to officially step down as CDU party leader at the December 2018 conference.
• No Reelection Bid As Chancellor: In the 2021 national elections for German chancellor, Merkel committed to not seeking reelection.
• Will Not Participate In A Snap Election: Merkel also stated that she would not run for chancellor in the event that a snap election was called before 2021. If a snap election were to be called, a nominee other than Merkel would represent the CDU.
• Political Retirement: Merkel publicly alluded to not seeking any elected office after her fourth term as chancellor expires in 2021.

In the weeks that followed the announcement, the EUR experienced significant challenges in addition to the fresh political uncertainty. Issues surrounding a deal-or-no-deal Brexit served to destabilize currency valuations. As a result, the month of November 2018 produced mixed performance for the EUR against the majors:

*For the same period, the XAU/EUR posted moderate gains of 0.50%. This represented a loss in value of the EUR against gold bullion.

While the aftermath did not devastate the EUR against the other global major currencies, weakness was apparent versus traditional safe-haven assets. Valuations lagged against gold and the Swiss franc (CHF), suggesting currency investors were actively seeking alternatives to holding euros.

Growing Political Divide

Merkel's resignation came at a time political analysts have dubbed as being a significant low point of CDU strength in Germany. Recent elections indicated a massive decline in party support from the electorate, specifically in Hesse and Bavaria. The results of these regional elections served to undermine the ruling CDU party's authority:

• Hesse: The CDU managed to secure only 27% percent of the vote. This figure was down 11% from the previous election and fell to levels last observed in 1966.^[3]
• Bavaria: CDU coalition party affiliate the Christian Social Union (CSU) dramatically underperformed against expectations. The CSU managed to garner 37.2% of the vote, down 10% from 2013. In addition, the CSU's tally fell below 40% for the first time since 1954.^[5]

The underperformance of the CDU/CSU in Hesse and Bavaria has been widely attributed to the issue of immigration. Merkel's 2015 decision to leave Germany's borders open to an influx of Middle Eastern refugees proved to be a pivotal issue, boosting the popularity of nationalistic themes. Growing support for the Green party and right-wing Alternative for Germany (AFD) is cited as being a primary driver of 2018's electoral outcomes.^[6]

The results in Hesse and Bavaria came as a shock to many, especially following the unification of the CDU, CSU, and Social Democratic Party (SPD) earlier in the year. In March 2018, Merkel led extensive efforts to unite domestic political powers and adopt tougher immigration standards. The 12 March 2018 announcement of a "grand coalition" between the CDU, CSU, and SPD alluded to a more hard-line immigration stance for Merkel's fourth term as chancellor.^[7] Following the announcement of the coalition, the EUR performed well against global majors, showing strength for the month of March 2018:

*For the same period, the XAU/EUR fell 0.28%, representing a gain in the EUR vs gold bullion.

Aside from modest losses versus the British pound sterling (GBP), the euro posted significant monthly gains. Driven by positive sentiment stemming from the coalition formation, market participants took an optimistic view of the euro and German political unity. However, the stability proved to be short-lived as turmoil from the 2018 regional elections ultimately prompted Merkel's exit from the CDU and post of chancellor.

Germany's Economic Role In The EU

Lauded as Europe's strongest economy, performance of the manufacturing, agricultural, and financial sectors factor greatly into Germany's contribution to the gross domestic product (GDP) of the EU. Germany consistently sits atop all EU members in terms of percentage of total GDP, such as the year end 2016 when Germany accounted for a 21.1% share of the EU's aggregate GDP.^[8]

In addition to economic output, Germany ranks as a top-five annual contributor to the EU budget along with France, the U.K., Italy and Spain.^[9] Given these levels of contribution, it stands to reason that political factors impacting the future of German commerce will influence the strength of the EU and euro.

One issue particularly worrisome for currency market participants is the scheduled 29 March 2019 Brexit transition and evolution of the European financial landscape. London, England serves as Europe's premier financial center with Frankfurt, Germany coming in a close second. In anticipation of Brexit, leading investment banks announced the relocation of more than 3,000 jobs to Frankfurt from London. The move was widely viewed as being the beginning of a financial restructuring of the eurozone.^[10]

However, the perceived power vacuum created by Merkel stepping down, coupled with growing opposition party power, has cast doubt upon Frankfurt being the future financial capital of the EU. Amsterdam, Brussels and Paris are popular locales for the leaders of global finance and may prove to be viable alternatives.^[11]

Growing uncertainty regarding the selection of an EU financial headquarters, or the failure to craft a U.K./EU financial-services deal, may prove detrimental to German economic output levels as well as those of the entire eurozone. Potential fallout may serve to undermine EUR valuations in both the intermediate and long-term.

Summary

As a general rule, markets are not fond of uncertainty. Beit political or economic, ambiguity can wreak havoc on the valuations of currencies, commodities or equities. The late-October 2018 announcement by Angela Merkel of pending political retirement provided forex traders with an abundance of food for thought. Immediate volatility plagued the EUR as well as in the weeks that followed.

However, the long-term impact of the announcement on the EUR remains to be seen. Merkel's stepping down as Chancellor of Germany was emblematic of lagging support for the CDU party. Given the potential reforms likely to come with new leadership, political and economic uncertainty may play a big role in EUR valuations for years to come.