Angela Merkel wins again and the market smiles.
Well done, Angela! What a result to win her 3rd term as chancellor. If she serves the whole 4 years, she will be leading Germany for 12 years since November 2005, half a year longer than Margaret Thatcher had led UK.
Merkel spent a great deal of her second term holding the Eurozone together. Germany is the biggest contributor to EUR 496 billion rescue aid. The widely speculated “Grexit” did not happen although there was a lot of stressful debates over Merkel German austerity stand versus Draghi European Central Bank “Whatever it takes” gesture. The European Central Bank Outright Monetary Transactions (“OMT”) is similar to US Quantitative Easing and Asset Purchase Scheme. Through OMT, European Central Bank was buying sovereign bonds issued by Eurozone member states. Media made jokes about OMT that it stands for “On Merkel’s Tap”.
For people who have been investing in Germany since Merkel’s leadership, there should be a lot of smiling faces. DAX, the German stock market benchmark index, has returned 68% since Merkel became chancellor in November 2005 versus a 15% drop in Eurostoxx 50 in the same period.
As for the German citizen, German unemployment rate is 6.8% compared to 12.1% in the 17-nation euro region. German 10-year bond yields are 1.94% while UK gilts yield 2.92%. Bond yield is a good reference of cost of funding. If German government can borrow cheaper than UK government, German corporates are also likely to enjoy a lower base rate reference than British corporates.
What I found most impressive is that in November 2005, EURUSD was 1.164-1.209 and GBPEUR was 1.454-1.491. On 23 September, EURUSD is 1.352 and GBPEUR is 1.187. EUR has appreciated against both USD and GBP in the past 8 years. Euro crisis is painful but the Financial Crisis was also brutal to US and UK.
With Merkel in the helm for another 4 years, the 3rd Greek bailout could not be in better hands. Yes, Merkel is tough and she will play her austerity card. She also has been there, done it with the 1st and 2nd Greek bailout. She knows the drill to balance saving Greece from “Grexit” and winning support from domestic voters. Merkel retaining her office brings stability to Eurozone.
The next big question in the investment world is “Who is going to be Bernake’s successor?”. The market expects Bernake to step down in January 2014. The spot light is on Vice Chairman Janet Yellen. Bernake has managed to turnaround the stock market and bond market from financial crisis. “Too big to fail”was managed and now regulators are throwing new rules that are phone book size to prevent any too big could exist. The FED Chairman still needs to tackle unemployment rate in US. The solution could be shale gas, a scientific technology rather than buying more bonds. Shale gas has massively lowered US manufacturing cost and sucking jobs back from the emerging markets like China. It is a Mary-Go-Round. Shale gas lowers energy cost to a level that offsets cheap labour cost in emerging markets for certain products.
The other difficult task for Bernake’s successor is that he or she cannot lower interest rate or increase Asset Purchase Scheme to simulate the economy. Both tools have been “used up” by Bernake after pushing interest rate to practically 0% and purchasing USD 85 billion asset a month. These are like steroid to the market and the new FED Chairman cannot add dosage. So what monetary policy can he or she use? Forcing banks to lend to Small and Medium Enterprises? Or learn from China to put up with massive growth in shadow banking?
Beside US economy, the FED Chairman role has big impact to the rest of the world. India Rupee almost got knocked out in August when Bernake talked about tuning down quantitative easing. The currency for 1.2 billion people depreciated as much as 13.8% against USD in August and recovered well in September by about 10% as the FED decided to maintain current Asset Purchase Scheme. Sure there were a lot of hedge funds and professional traders taking a ride but the trigger is US FED.
To sum up, with Merkel’s victory, a big piece of the Eurozone puzzle is now in the right place. Investors should expect more of the same. The big question market is now on Bernake’s successor and what can he or she do more or less than Bernake. This has big impact to emerging markets.
