Defence and tariffs top the agenda at Merz and Macron working dinner

French President Macron and German Chancellor Merz recently met in Berlin, focusing on critical defence cooperation, EU-US trade tariffs, and energy policy. The Future Combat Air System (FCAS) fighter jet project is under pressure due to inter-company rivalries and concerns over Macron's diminishing influence, with its failure potentially jeopardizing the linked MGCS tank project. This defence uncertainty is particularly significant as Europe aims to enhance its strategic autonomy amid a potential reduction in US contributions. Discussions also covered imminent EU-US tariff negotiations.

Analysis

The recent meeting between French President Macron and German Chancellor Merz underscores significant friction in core European policy, particularly concerning joint defence initiatives. The flagship Future Combat Air System (FCAS) and the Main Ground Combat System (MGCS) tank project are facing considerable headwinds due to inter-company rivalries involving Dassault, Airbus, and Indra, compounded by political maneuvering. President Macron's diminishing political influence ahead of his 2027 term end is reportedly fueling demands for project renegotiation, which Germany is unlikely to accept. The potential failure of FCAS threatens a "domino effect" that could collapse the MGCS project as well. This instability is critical as it jeopardizes Europe's push for greater strategic autonomy at a time when contributions from the United States are perceived as less certain. While the overall sentiment is moderately negative and reflects this uncertainty, discussions on EU-US trade policy offer a contrasting point, with an imminent deal to avert 30% tariffs considered likely. Despite superficially improved Franco-German relations, these deep-seated disagreements on strategic industrial policy highlight a significant execution risk for the European agenda.

Key Decisions for Investors

• Investors should exercise caution regarding European defence equities with high exposure to the FCAS and MGCS projects, as the heightened political and corporate infighting creates significant risk of delays or cancellation.
• Monitor the progress of Franco-German defence negotiations as a key barometer for European political cohesion and the continent's ability to achieve strategic autonomy, which has long-term implications for regional stability and investment risk.
• While the defence sector faces uncertainty, a potential near-term resolution of the EU-US tariff dispute could serve as a positive catalyst for European exporters, suggesting a possible tactical opportunity in industrials and consumer goods.
• The political friction between Europe's two largest economies could introduce volatility, so it is prudent to watch for any widening of the French-German sovereign bond spread as an indicator of rising political risk premium.