How Germany's political crisis could impact markets and trading​

Understanding Germany's political crisis

The collapse of Germany's three-party coalition government has thrown Europe's largest economy into turmoil. Chancellor Olaf Scholz's dismissal of Finance Minister Christian Lindner marks a critical turning point in German politics.

The political upheaval comes at a particularly challenging time, with Germany already grappling with economic headwinds. The uncertainty has raised concerns about the country's ability to implement crucial economic reforms.

Caretaker government limits policy actions

Recent events have left Germany effectively under a caretaker administration ahead of potential snap elections in March. This political limbo severely limits the government's capacity to enact new policies or respond to economic challenges.

Rising far-right influence reshapes politics

The situation is further complicated by rising support for the right-wing Alternative für Deutschland (AfD) party, which could reshape Germany's political landscape. Going forward, traditional parties may face unprecedented challenges in forming stable coalitions with negative implications for the already struggling German economic powerhouse, which used to be Europe’s driving engine but now seems to be holding the continent back.

Impact on German markets and sectors

Automotive and banking sectors hit hard

​The political uncertainty has particularly affected German shares, with key sectors facing significant headwinds. The automotive industry, led by Volkswagen, is struggling with transition challenges. The company, taken by surprise by the rapid rise of electric cars, has become a symbol of Germany's economic woes, and recently asked staff to take pay cuts, warning it may shut plants in the country for the first time in its 87-year history.

​Banking stocks, including Commerzbank, face additional pressure as the political vacuum complicates potential merger situations. The lack of clear government direction makes it harder for companies to plan strategically.

Export challenges and economic predictions

​Germany's export-dependent economy could face significant challenges, with some economists predicting a potential 1.5% economic contraction in 2027 and 2028 were US tariffs on the country’s exports to be introduced.

​According to LSEG, German company earnings are expected to fall 2.8% in the third quarter (Q3), behind countries like Spain and the United Kingdom. That compares with a more than 8% rise expected across Europe in general.

​The negative German outlook has impacted sentiment on the euro and German stock market across European trading platforms.

Impact of uncertainty on German DAX 40 index

Volatile trading amidst political shifts

​The uncertainty has created volatile conditions for traders focusing on German markets, with the DAX 40 showing increased sensitivity to political developments.

​This was evident on the day of the US presidential election when the German DAX 40 stock index at first rallied in line with its US peers before ending the day in negative territory while US indices rallied by 2%-to-6%, several hitting record highs.

​DAX 40/US stock indices 5-day percentage comparison chart

Post-US election market movements

The day following the US election, the DAX 40 regained lost ground, rallying by 1.7% in line with US markets. The German stock index was propped up by Chancellor Scholz’s hastily arranged news conference on Wednesday evening, in which he promised to deliver a raft of measures for approval in December on issues like pensions and immigration, as part of a 49-point growth package.

​German DAX 40 daily candlestick chart

Technical analysis of the DAX 40

From a purely technical perspective, the DAX 40 remains within its long-term uptrend and will continue to do so while it trades above its early October low at 18,912 on a daily chart closing basis.

Should the early October low give way, however, a fallback towards the September low and the 200-day simple moving average (SMA) at 18,329 could be envisaged.

Global trade tensions and Germany's economic landscape

Global trade tensions have added another layer of complexity to Germany's situation. The prospect of increased tariffs from major trading partners such as the US under the newly elected President-elect Donald Trump threatens to further strain the export-focused economy. It remains to be seen whether President-elect Trump’s often touted 20% tariffs on Europe will actually be implemented, though.

Impact of international relations on market sentiment

Relations with China, Germany's largest trading partner, remain crucial for market sentiment. Any deterioration in these ties could significantly impact German industrial stocks and broader market performance.

Euro under pressure amidst political and economic challenges

The euro faces potential pressure as political uncertainty combines with economic challenges. Currency traders are closely monitoring developments for signs of stability amid increased volatility in the exchange rate.

​EUR/USD daily candlestick chart

Market movements post-US election

Following a 2% drop to four-month lows on the back of Donald Trump’s presidential election victory, which provoked a surge in the US dollar, the euro managed to regain some of its losses following the US Federal Reserve’s (Fed) widely anticipated 25 basis point rate cut to 4.50% to 4.75%.

Euro's potential recovery path

As long as this week’s $1.0683 low underpins, the EUR/USD exchange rate may recover into year-end and trade back around the $1.1000 mark. A fall through the $1.0683 level and the June low at $1.0668 would put the April trough at $1.0602 back on the map.

Interplay of global factors and domestic politics

​The outcome of potential snap elections could significantly influence market direction. Traders should monitor polling data and potential coalition scenarios. Economic indicators will be crucial in assessing the impact of political uncertainty on German business confidence and investment.

The resolution of key policy issues, particularly around industrial strategy and energy transition, could provide catalysts for market movements. Global factors, including trade relations and monetary policy developments, will continue to interact with domestic political concerns.