Market Brief: Euro Rises As Moderates Win German Election

The euro is trading with a supportive bias after a centre-right party emerged victorious in Germany’s federal election, avoiding a lurch into extremist territory and paving the way for business-friendly economic reforms. The Christian Democrats led by Friedrich Merz are believed to have won 28.5 percent of the vote against the far-right Alternative for Germany’s 20.8 percent, 16.4 percent for the centre-left Social Democrats, 11.6 percent for the Greens, and 8.8 percent for The Left. The government could find it difficult to enact broad-reaching defence and fiscal policy changes—given that parties on the extreme left and right have enough votes to form a “blocking minority” in the Bundestag—yet Merz is nonetheless now expected to work with the Social Democrats to form a governing coalition focused on reducing taxes, loosening red tape, and providing more support to the military.

Trans-Atlantic relations could be set for more turbulence. President Trump welcomed Merz’s victory*, saying that it showed Germans—like their American counterparts—had turned against the "no common sense agenda, especially on energy and immigration”. But trade frictions remain, and within hours of polls closing, the incoming chancellor acknowledged a radical shift in foreign policy, saying that he would seek to “strengthen Europe as quickly as possible, so that we achieve independence from the US, step by step… I never thought that I would ever need to say something like that, on television, but after the latest statements made by Donald Trump last week, it is clear, that the Americans—at any case these Americans, this administration—mostly don't care about the fate of Europe one way or another”. Trump last week appeared to accuse Kyiv of starting the war in Ukraine, and his administration has pivoted toward supporting Russia at a speed that has astonished even hardened foreign policy observers. Option butterflies, which measure demand for hedges against extreme exchange rate moves, suggest that the weekend’s election hasn’t materially lowered perceived geopolitical risks in the euro area, meaning that the currency’s gains could remain capped for now.

The greenback is almost unchanged after the University of Michigan’s consumer sentiment survey suffered a gut-wrenching decline in early February, dropping to its weakest levels since November 2023. US equity markets plunged and risk-sensitive currencies sold off against their safe haven brethren when the University’s latest update was released Friday morning—driven by fears that the Trump administration’s trade, immigration, and fiscal policy moves might derail the economy’s long expansion—but a recovery is now underway, suggesting that the initial reaction was overdone.

The cadence of potential volatility catalysts will pick up in the days ahead.

The Conference Board’s measure of US consumer confidence probably weakened in February, but not by as much as the more partisan-driven University of Michigan sentiment index. A drop below 102.5 from the previous 104 level could trigger a renewed selloff in equity markets as investors brace for more economic turbulence ahead.

Wednesday’s Nvidia earnings release could rock markets. Trading in the $3.3 trillion chips behemoth—bigger than most national stock markets—has become more challenging in recent months as doubts over the artificial intelligence rally’s sustainability have crept in, and as the emergence of processor-light large learning models like the Deepseek has challenged the outlook for demand. A disappointment could dampen global risk appetite and boost the dollar, while another blowout quarter coupled with optimistic guidance might see high-beta currencies like the Canadian dollar gain in relative terms.

The focus will briefly shift outside the US: Inflation prints from Germany and Spain on Thursday, followed by France and Italy on Friday will help set the stage for next week’s bloc-wide release and help calibrate expectations for the European Central Bank’s policy path, and on Friday, Canada will publish fourth-quarter gross domestic product numbers, hinting at the strength of the growth handoff into 2025.

Rude surprises are fairly unlikely when the US updates the Fed’s preferred inflation measure—the core personal consumption expenditures deflator—on Friday, but the accompanying personal spending numbers could cause some upset. Based on previously-released consumer and producer price data, price growth is seen dropping into the 2.6-percent neighbourhood in the year to January, even as it accelerates slightly to somewhere between 0.250 and 0.275 percent on a month-on-month basis—giving policymakers reason to stay on hold for longer. Consumer spending may have moved in the opposite direction, with purchases of big-ticket items shrinking relative to December as households turned more cautious on the future.

Beyond the hard numbers, investors will be watching for news on the tariff front—Trump’s postponement of levies on Canada and Mexico is set to expire on March 4–and keeping a wary eye on movement toward a government funding deal ahead of the March 14 debt ceiling deadline. Republicans in the Senate and House are working on rival measures to extend tax cuts, tighten border security, and increase military spending, but a small number of budget hawks remain opposed to plans that would substantially increase budget imbalances over the next decade, and haven’t been satisfied by the Department of Government Efficiency’s noisy but relatively-trivial cost-cutting efforts thus far. Markets would welcome the successful passage of a funding bill, but without major cuts to defence and entitlement programmes, the US government deficit appears likely to remain the biggest in the world for many years to come - meaning that investors may have to keep swallowing outsized issuance volumes, keeping interest expenses near record levels.

*Apparently forgetting that Merz represents Angela Merkel's old party.

Economic Calendar