The withdrawal of the small centre-right FDP from the German talks amid disagreements with Chancellor Merkel’s CDU and the Green Party over issues ranging from asylum to tax and environment raises the chances of Germany having to return to the polls, even though Merkel will meet with the country’s president later on Monday to consider other options – including a minority administration.
The risk for markets is that the outside chance of a new election embeds fresh uncertainties about who runs Europe’s biggest economy, gives the anti-euro far-right AfD another chance of registering their popularity and representation, weakens any new push on further euro zone integration and reduces the chances of easier German fiscal policy at the margins.
Euro/dollar was down about 0.4 percent in early trading as a result, with euro/yen hitting a two-month low. For business and the economy, however, euro weakness may be an offsetting silver lining that underpins one of the fastest German expansions in years. German bund yields were lower on a slight tilt to safety, with peripheral euro sovereign debt spreads widening a touch.
Euro stocks were expected to open down about 0.5 percent, with Germany’s DAX underperforming and on course for losses of about 1 percent to 7-week lows. European Central Bank chief Draghi testifies to the European Parliament later on Monday.
Asia bourses were more mixed, with eyes on the Chinese financial sector regulation limiting high-yield investments in wealth management vehicles from 2019 and another day in the red for Wall St on Friday. Shanghai and HK stocks ended higher after initial losses, however, even though Tokyo and Seoul closed down.
Despite the fresh political and regulatory jitters, markets have been unnerved over the past week by concerns about the impact of Federal Reserve tightening on the economic cycle – with the U.S. 2-to-10 year yield curve falling to a new 10-year low below 62 basis points on Friday. Markets are also suffering from periodic bouts of profit-taking in Thanksgiving week in the States, a week that for some winds up financial investment plans for the year.
Sterling was firmer against both the dollar and the euro ahead of the UK budget on Wednesday and with more press reports that the British government is prepared to increase its offer of money to settle the Brexit divorce bill as a way of advancing stalled talks with the European Union by next month's EU summit.
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Editing by Alison Williams