‘Stuck in the mud’: one year on, Friedrich Merz struggles to find his footing

One year into Friedrich Merz’s chancellorship, Germany’s coalition is plagued by record-low support, internal tensions, and doubts about its ability to manage the economy. The article highlights specific headwinds including surging fuel prices, Trump-linked trade penalties on European cars, a potential drawdown of at least 5,000 US troops from Germany, and continued weakness in the car industry. While the government points to cuts in asylum applications and higher defense and infrastructure spending, the dominant message is political fragility and policy paralysis in Europe’s largest economy.

Analysis

The market implication is not a clean “Germany weak = Europe down” trade; it is a widening dispersion trade inside Europe. The real first-order loser is cyclical German domestic beta: autos, industrials, construction-linked names, and mid-cap employers that need policy coherence and household confidence to translate fiscal spending into order books. The second-order winner is not obvious rate-sensitive duration, but defensive cash-generators with overseas revenue and pricing power, because a credibility gap in Berlin tends to delay capex decisions more than it changes long-run fiscal capacity.

The bigger macro risk is that policy paralysis collides with external shock transmission. If Berlin cannot anchor a credible response to tariffs, energy volatility, and defense spending, the euro area growth impulse from fiscal expansion will leak into higher imports and lower execution rates rather than domestic demand. That is bearish for German autos and machinery over the next 3-6 months, while modestly supportive for US and Asian competitors that can take share in pricing-sensitive segments. Defense remains a relative winner, but only where procurement translates into actual awards rather than headline budgets.

The contrarian view is that this is already well known in German equities and may be more political than market-relevant unless coalition dysfunction becomes legislative gridlock. The real catalyst is not approval ratings; it is whether the government loses the ability to pass budget, industrial, and defense measures before year-end. If that happens, expect a fast reset lower in Germany-linked cyclicals and the euro, with a spillover into European bank and industrial sentiment.

The near-term reversal scenario is simple: a credible fiscal package, a calmer transatlantic line, or a concrete industrial-policy win would compress the political risk premium quickly. Absent that, the path of least resistance is lower for domestic German cyclicals and higher relative performance for firms exposed to non-German demand and structural defense spending.

Key Decisions for Investors

• Short DAX via futures or EWG on strength; target 4-8 week horizon. Use as a hedge against Germany-specific policy disappointment, with tighter risk if coalition delivers a budget compromise.
• Long SAP / short German autos (e.g., BMW, MBGYY, VOW3.DE) as a 3-6 month pair. Thesis: software and global recurring revenue are less exposed to domestic confidence and tariff-induced margin pressure than hardware-heavy cyclicals.
• Overweight European defense beneficiaries with execution leverage, not just headline exposure: LDO.MI, RHM.DE, and ESGR-style contractors where order conversion is visible. Time horizon: 6-12 months; trim if procurement slows or funding gets reallocated.
• Buy EUR/USD downside via puts or put spreads for 1-3 months if coalition headlines deteriorate. Risk/reward improves if Berlin’s credibility loss becomes a growth narrative rather than a pure political story.
• Avoid initiating fresh longs in German domestic cyclicals until there is evidence of legislative follow-through; if already long, reduce into rallies and keep a stop tied to budget/industrial-policy milestones.