German election impact on the Global High Yield Market

George Flynn, Global High Yield Bond Fund Manager

Mark Remington, Global High Yield Bond Fund Manager

With their ongoing poor economic performance, Germany is quickly becoming “the sick man of Europe.” Real GDP growth in Germany has been stagnant for many years now, with median real GDP growth since mid-2018 of only +0.1% per year. Although external factors have weighed on growth, such as the 2022 energy price spike from the Russia/Ukraine war, and the European Central Bank rate hikes to combat the 2022 rise in inflation, many commentators suggest that structural issues have been, and continue to weigh on the economy, namely, ever-increasing over-regulation, a high tax burden, and ongoing high social welfare spending. Despite these issues, the image of Germany is Europe’s predominant industrial power. However, recently this narrative has been shaken. In Q3 2024 the industrial sector saw real GDP growth of -1.4%, and last year many stories emerged around how large German companies, such as Volkswagen and BASF are downsizing their presence in Germany.

On 23 February, the German people go to the polls. The CDU (Christian Democratic Union) is likely to win the most seats on a promise of tax cuts, a smaller welfare state, and controlled immigration. At the margin, and in the long run lower taxes and a smaller welfare state seem to be positive from an economic growth standpoint. However, the CDU is not expected to win an outright majority, with polls giving them about 30-35% of the vote, meaning they will have to form a coalition with either the SPDs (Social Democratic Party) or Greens, making the CDU’s planned reforms more difficult to pass.

A near term boost for GDP growth could come from passing legislation that allows Germany to increase their borrowing limit. As we stand, by law Germany cannot increase their debt by more than 0.35% annually, putting a limit on the government’s ability to stimulate the economy in the short term through increased spending. However, to pass this legislation, the bill needs a two-thirds majority, and currently both the CDU and AFD (Alternative for Germany), the two largest parties in Germany according to the polls, do not support the idea.

How will the election impact the high yield market? For a start, Germany is only a small part of the global high yield market, making up 2.5% of the ICE BofA global high yield index. It’s the seventh largest country in the index, sitting behind Brazil. So, despite the large economy, the presence of Germany in the high yield market is limited. Given the small size in the index, anything material that happens in Germany is likely to have a limited direct impact on the index. On top of this, although the CDU is talking about reforms, most of these are long term in nature, and although the increase of the federal spending limit could be a near term positive, the legislation will be tough to get through as it needs a two-thirds majority.

Looking closer at the German high yield market, the largest sectors are autos, industry (basics and capital goods) and healthcare. A change in government is very unlikely to be the driver of performance in these spaces. The autos space is a mess, due to weaker consumer demand from higher interest rates since 2022, and EU quota-based electric vehicle regulations causing profitability issues for European original equipment manufacturers (OEMs). Within healthcare, the big players are all facing idiosyncratic issues. Bayer has challenges with Roundup litigation and operational performance, Stada is looking to be sold by their private equity sponsors, and Cheplapharm has operational manufacturing and supply issues. Within the industrial space, most of the risk is Thyssen Elevators, which makes up around 40% of the sector, and although it’s a German company, the overwhelming majority of its business comes from abroad.

In summary, like most elections that don’t lead to radical change, the impact of a change in government will likely have a limited impact on the markets in the near term. From a portfolio point of view, we are keeping an eye on a potential tail risk of the AFD gaining power, as this may create volatility in the market which could present an interesting entry opportunity.

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