How the German Election Could Dictate Europe’s Future Direction

As Germany prepares to go to the polls in its general election, David Zahn, Franklin Templeton Fixed Income Group’s head of European fixed income, considers what the result could mean for Europe, the European Union and the eurozone. He also reviews the recent State of the Union address from European Commission President Jean-Claude Juncker for clues as to what the future might hold for investors—even for those outside of Europe.

European Commission President Jean-Claude Juncker’s State of the Union address last week was notably more forthright and aggressive than we’ve come to expect from him. But I think the timing was significant.

These are optimistic times in Europe, in general. In contrast to what many observers might have expected nine months ago, we believe the political structure in Europe is probably the most stable it’s been in 10 years.

Stability Reigns in Europe

Indeed, we’d argue that today Europe is more stable politically than some other parts of the world, such as the United States, where we’d usually expect stability.

From an investment perspective, that stability has been reflected in how investors have been recently allocating their investment dollars. Growing appetite for European assets has corresponded with the perceived improvement in the political outlook.

And while that stability will be tested again later this week as Germany goes to the polls in its general election, a cautious self-confidence was apparent in Juncker’s State of the Union address.

The European Commission president re-emphasized his federalist agenda, outlining a number of approaches designed to bring the region closer together politically and economically. These include a closer banking union, a closer fiscal union, a single European Union (EU) foreign policy and complete adoption of the euro across the EU.

In our view, an obvious potential outcome of this push for integration and fiscal union is the emergence of a European bond.

We see this as a long-term issue, but if Europe starts heading down this road we’d expect to see bond and currency markets in the region become more homogenous. That of course also implies there could be less opportunity between the national governments because spreads would likely compress.