Germany’s Election Results in Gridlock

Editors’ note: MarketMinder is nonpartisan, favoring no party nor any politician. We seek solely to deduce political developments’ potential market ramifications.

After months of buildup, Sunday’s German federal elections offered little surprise. New Chancellor-in-waiting Friedrich Merz’s Christian Democratic Union (CDU)—and its Bavarian sister-party, the Christian Social Union (CSU)—are set to return to government for the first time since former Chancellor Angela Merkel stepped down in 2021. Some lingering questions remain. Namely, lacking a majority, with whom will the CDU/CSU govern? But with the results in, political uncertainty is fading, letting markets move on.

Results mostly matched polls. The CDU/CSU’s 28.5% vote share took the plurality and thus translates into the most seats in the Bundestag, though somewhat disproportionately. While this puts the CDU/CSU in pole position to form a new government, they need at least one coalition partner to rule. What configurations are possible? Exhibit 1 shows parties’ vote share and the parliamentary seats of the now 630 (down from 735) they won.

Exhibit 1: How Germany’s Vote Shook Out

Source: Bundeswahlleiterin.de, as of 2/23/2025.

Although the second-biggest vote getter was the Alternative for Germany (AfD), given its far-right reputation, it is radioactive to other parties. Pre-election, all non-AfD parties vowed not to partner with it. Next were the incumbent coalition partners Social Democratic Party (SPD) and Greens, then the Left Party, the Sahra Wagenknecht Alliance (BSW), Free Democratic Party (FDP) and Stefan Seidler (SSW).

Notably, the upstart BSW and erstwhile SPD-Green coalition partner FDP fell below the 5% threshold for parliamentary entry (the second time the FDP’s participation in a coalition government destroyed its support). This was one of the biggest issues heading into the election: How much support would they draw away from larger parties? Now we know they will garner no Bundestag seats—which boosts remaining parliamentary parties’ allocations. SSW—a Danish and Frisian party—isn’t subject to the vote threshold.

Still, the CDU/CSU’s options are limited. Their most likely candidate to partner with: outgoing Chancellor Olaf Scholz’s SPD, which would give the prospective coalition 328 seats, a 13-seat majority. Markets are so familiar with a CDU/CSU-SPD configuration it has a nickname: the “Grand Coalition.” Indeed, Merkel presided over such a government in three of her four terms when the CDU/CSU dominated Germany’s electoral politics from 2005 – 2021. While it isn’t a given they will renew their partnership this time, most see it as a foregone conclusion.

A two-party coalition would probably be slightly less unwieldy than the three-party coalition that broke up in November—leading to Sunday’s snap vote—but we think gridlock is still likely. Although it is easier for two parties to negotiate than three, given their policy differences, it could still take time to hammer out an agreement. For example, the CDU/CSU wants to cut taxes, remove red tape and raise defense capabilities, but the SPD favors tax hikes, higher minimum wages and strengthening the pension system.

But what all these plans do have in common: They would likely require more net spending. Hence, headlines’ focus on Germany’s so-called “debt brake,” which the CDU/CSU-SPD coalition in 2009 enshrined constitutionally, restricting the federal government’s net borrowing to 0.35% of GDP. Pundits frequently blamed it for limiting public investment and, therefore, Germany’s current economic plight. (We disagree, more of which momentarily.)

Getting around the debt brake would take another constitutional change—requiring a two-thirds supermajority (420 Bundestag votes), which the Grand Coalition would lack even if it could muster support from the Greens. That raises the question of whether the AfD or the Left Party might support the motion as well. Although possible, both are leery. The AfD opposes increased defense spending (aimed at countering Russian aggression). So does the Left, but for different reasons. It is no fan of the debt brake, so though theoretically amenable, it would like to see funds raised for social programs rather than military enhancements or tax cuts. While concessions are possible, amending the debt brake remains a tall order, in our view.

That said, we don’t think Germany’s markets need a big fiscal boost—and gridlock’s preventing one isn’t a headwind, in our view. All stocks need to do well is for reality to exceed expectations. With the economy shrinking slightly each of the past two years—and many expecting a perma-slump (especially without government action)—even meager growth or less contraction than feared could provide upside surprise. Moreover, under the hood, household consumption—German GDP’s biggest component—is chugging along better than appreciated, while global manufacturing is showing signs of firming. Besides, many German firms generate significant revenue outside the country, making non-German economic conditions a critical consideration.

That doesn’t mean the economy is set to fire on all cylinders, but gangbusters growth—or a fiscal push to induce such—isn’t necessary. Consider: German markets were fine last year without either. Stagnant GDP isn’t great, but it isn’t the recession many expected. Government gridlock may be frustrating, but it prevents radical reform—lowering uncertainty—and promotes stable and predictable business conditions. Also, public investment isn’t auto-positive. Recent years show this, with all the investments in clean energy that aren’t paying off. Misallocated fiscal spending risks having investors chase it into unproductive/unprofitable ventures, which can create missed opportunities elsewhere. Always remember: Government spending, legislation and regulation very often pick winners and losers that may be suboptimal.

With sentiment so sour, less bad is likely good enough for stocks. And with politics functionally little different from before—likely CDU/CSU-SPD gridlock instead of the SPD-Green flavor—German stocks don’t seem to mind. The MSCI Germany Index hit record highs in euros and dollars last week ahead of elections and is up 12.6% and 13.9% year to date, respectively in each currency, beating the MSCI World Index.^[i] As political uncertainty recedes further and growth proves better than perceived, German outperformance likely continues.