Germany's Political Shift: Merz's Chancellorship and Its Economic Implications

The historic second-round vote to elect Friedrich Merz as Germany’s tenth postwar chancellor on May 6, 2025, marks a pivotal moment for Europe’s economic powerhouse. While Merz’s victory secures his leadership, the narrow margin of victory—325 votes in the second round—exposes underlying political fragility. For investors, this transition raises critical questions: How will Merz’s agenda impact Germany’s economy? What sectors stand to benefit—or suffer—from his priorities? And what risks does political instability pose to European markets?

Merz’s Fragile Start and Policy Priorities

Merz’s path to power was unconventional. His failure to secure a majority in the first round of voting—a first in postwar German history—revealed cracks in the CDU/CSU-SPD coalition. Analysts note this could weaken his ability to push through ambitious reforms. Merz has emphasized three core goals:
1. Tightening migration controls, including stricter asylum policies.
2. Boosting defense spending, aiming to meet NATO’s 2% GDP target.
3. Reasserting German leadership in the EU, particularly on energy and security.

These priorities have immediate implications for sectors like defense, manufacturing, and renewable energy.

Defense Sector: A Bullish Outlook?

Merz’s pledge to increase military spending aligns with Germany’s post-Ukraine war pivot. The defense sector could see significant investment. Companies like Krauss-Maffei Wegmann (KMW), a leading producer of armored vehicles, and Rheinmetall (RHM), which supplies artillery systems, are likely beneficiaries.

Already, KMW’s stock has risen 22% year-to-date, outperforming the broader market. This reflects investor anticipation of higher defense budgets. However, execution risks remain: Merz’s coalition with the SPD, which has historically prioritized social spending over military, could complicate funding.

Manufacturing and Trade: Navigating Protectionism

Merz’s stance on migration and border control may clash with Germany’s export-driven economy. While stricter asylum policies could reduce labor shortages in sectors like manufacturing, protectionist rhetoric risks fraying global trade ties. The automotive sector—dominated by Volkswagen (VOW3) and Daimler (DAI)—depends heavily on EU and Asian supply chains.

The DAX has underperformed the Stoxx Europe 600 by 4% year-to-date, partly due to concerns over trade tensions. Investors should monitor Merz’s approach to bilateral trade agreements, particularly with China and the U.S.

Renewable Energy: A Divided Coalition

Merz’s focus on EU leadership may boost German influence over energy policy. His support for accelerating renewable energy projects could benefit firms like Siemens Energy (SIE) and NextEra Energy Europe (NEE). However, the SPD’s push for social spending could divert funds from green infrastructure.

The coalition’s internal tensions are already evident: SPD co-leader Lars Klingbeil, now Vice Chancellor, has publicly clashed with Merz over fiscal priorities. This dynamic could slow legislative progress, a risk for long-term infrastructure projects.

Risks: Political Instability and Global Sentiment

The far-right AfD’s continued criticism of the coalition’s stability adds volatility. A collapse of the Merz government would likely trigger snap elections, creating uncertainty for markets. Meanwhile, global investors are watching closely:

• Yen/Dollar Carry Trade: A weaker yen could pressure German exporters reliant on Asian markets.
• Eurozone Bond Yields: Rising rates in Germany could widen yield spreads with weaker EU members, testing eurozone cohesion.

Conclusion: A Delicate Balance for Investors

Merz’s chancellorship offers both opportunities and pitfalls. Defense and energy sectors appear poised for growth, but political fragility and coalition tensions could cap gains. Key data points to watch:
- DAX Index: A sustained breakout above 16,000 (its highest since early 2022) would signal investor confidence.
- KMW Stock: Outperformance of 15%+ from current levels would validate defense spending optimism.
- SPD Approval Ratings: Below 20% could signal coalition instability, a red flag for markets.

While Merz’s swearing-in marks a new era for Germany, the path ahead is fraught with execution risks. Investors should prioritize sectors aligned with his agenda—defense and energy—but remain vigilant to political headwinds. The coming months will test whether Merz’s vision can overcome the fractures within his coalition, or if Germany’s economy will pay the price.