Merz's Rocky Ascent - Germany's New Chancellor Reshapes European Economic Landscape
Merz's Rocky Ascent: Germany's New Chancellor Reshapes European Economic Landscape
BERLIN — The ornate chamber of the Bundestag fell into stunned silence on Tuesday as Friedrich Merz, the man poised to lead Europe's largest economy, watched vote counters announce he had fallen six votes short of the majority needed to become chancellor. What should have been a ceremonial coronation instead became a moment of political theater that sent tremors through financial markets and European capitals alike.
In the hastily arranged second round of voting that followed, Merz secured 325 votes—comfortably clearing the 316-vote threshold—and with visible relief offered a terse acceptance: "Thank you for your trust. I accept the election."
The unprecedented first-round rejection of a chancellor candidate in post-war Germany provides more than political drama. It offers a window into the contradictions and challenges that define Merz's surprising political resurrection and the radical economic pivot he now leads—one that combines massive fiscal stimulus with strategic rearmament in ways that could fundamentally reshape Europe's financial and security landscape.
Political Comeback Meets Parliamentary Rebellion
For Merz, 69, the path to the chancellery represents what one former colleague called "the most unlikely third-act triumph in modern German politics." Just seven years ago, the corporate lawyer who once served on BlackRock's German supervisory board was widely considered a political has-been, his career having ended following a long-running rivalry with Angela Merkel.
That rivalry, now part of German political lore, was famously summarized in Merkel's 2024 memoir: "There was one problem, right from the start. We both wanted to be the boss."
The February 2025 elections that returned Merz's Christian Democrats to power with 28.5% of the vote seemed to definitively answer the question of who would now be boss. Tuesday's parliamentary drama suggested otherwise.
"The secret ballot offered the perfect cover for settling scores," said Philipp Koeker, political scientist at Leibniz University Hannover. "At least 18 members of Merz's own coalition evidently voted against him in the first round, exposing fault lines that could undermine his ambitious agenda before it even begins."
Markets reacted swiftly to the uncertainty. The DAX plunged 1.9% immediately after the first-round failure before recovering to close down 0.5% by late afternoon.
DAX Index Reaction to Merz's Chancellorship Vote (May 6, 2025)
| Date | Event | DAX Reaction |
|---|---|---|
| May 5, 2025 | Markets anticipate Merz’s appointment | DAX rose over 1% |
| May 6, 2025 | Merz fails first-round chancellorship vote | DAX dropped ~1–1.8% |
| May 6, 2025 | Midday trading amid uncertainty | DAX down 1.1%; Bund yields dip |
| May 6, 2025 | Broader market impact | European stocks also declined |
"The markets detest uncertainty more than anything else," noted Carsten Roemheld, capital market strategist at Fidelity International. "Today's vote has suddenly added a political risk premium to German assets that wasn't there yesterday."
From Fiscal Hawk to Deficit Spender: The €1 Trillion Gambit
The parliamentary rebellion against Merz stems partly from his dramatic reversal on fiscal policy. Long known as a budget hawk who championed Germany's constitutional debt limits, Merz has executed a remarkable pivot, pushing through constitutional amendments to exempt significant spending from Germany's strict debt brake.
Germany's "Schuldenbremse," or "Debt Brake," is a constitutional rule designed to limit new government debt. This mechanism reflects a fiscally conservative approach, often championed by "fiscal hawks," aiming to ensure sound public finances by restricting borrowing.
The centerpiece of "Merzonomics" is a mammoth €1 trillion spending plan, including a €500 billion infrastructure fund spread over 12 years and €100 billion specifically earmarked for climate and economic transformation.
Merz’s €1 Trillion Investment Plan – Key Areas
| Category | Summary |
|---|---|
| Total Plan | €1 trillion over 10+ years focused on defense and infrastructure. |
| Infrastructure | €500 billion for transport, energy, digitalization, healthcare, and education. |
| Climate | €100 billion for green projects via the Climate and Transformation Fund. |
| Defense | Defense spending above 1% of GDP exempt from debt limits; includes Ukraine aid. |
| Economic Reform | Tax cuts, regulatory reform, and growth-focused initiatives. |
| Fund Split | €400B federal, €100B state (some sources say €300B/€100B for national/regional projects). |
| Digitalization | New digital ministry; significant funding from the infrastructure plan. |
| R&D | Targeting 3.5% of GDP in public-private R&D spending by 2030. |
"The failed vote clearly signals that not all within the CDU are aligned with the fiscal reversal," observed Carsten Brzeski, ING's Chief Economist for Germany. "Fiscal conservatives within Merz's own party are experiencing cognitive dissonance watching their standard-bearer embrace deficit spending on this scale."
The fiscal expansion represents the most significant departure from Germany's traditional economic orthodoxy since reunification. For investors, it means German bond issuance could rise by €80-100 billion annually for a decade—the first serious supply shock in a generation.
This profound shift has already steepened the Bund yield curve to its widest since 2013, with 10-year yields rising 60 basis points since the fiscal plan's March announcement. Some analysts project yields could reach 3.75% by 2026 absent intervention from the European Central Bank.
Did you know that Germany’s announcement in early 2025 of a historic €500 billion infrastructure fund and a major relaxation of its debt brake for defense spending triggered the largest weekly rise in 10-year Bund yields since the 1990s, with yields jumping over 40 basis points to near 2.9%? This fiscal shift, the biggest in 80 years, is expected to increase Germany’s bond issuance significantly-potentially by €30 billion this year and cumulatively €145 billion by 2028-pushing yields structurally higher, possibly toward 3%, as markets price in more government borrowing and less ECB bond buying. Despite this, Germany’s credit profile remains strong, with debt-to-GDP ratios still below G7 averages, and the fiscal boost is seen as growth-enhancing, supporting Eurozone economic prospects and influencing global bond markets.
"We're witnessing nothing less than the end of the Schwarze Null era," said one veteran bond trader at a major European bank, referring to Germany's "black zero" balanced budget policy. "The question now is whether Merz can deliver enough growth to justify the debt burden he's taking on."
Did you know? Germany’s “Schwarze Null” (“Black Zero”) policy was a commitment to maintaining a balanced federal budget with no new debt, aiming to promote fiscal discipline and reduce national debt. Officially adopted in 2014, it became a symbol of Germany’s conservative economic stance, though critics argued it hindered public investment in areas like infrastructure and digitalization. The policy was suspended during the COVID-19 pandemic to allow emergency spending, sparking ongoing debate about its future in a changing economic landscape.
From Budgetary Constraint to Military Might
Parallel to the fiscal expansion is Merz's commitment to cementing Germany's unexpected new role as Europe's leading defense power. Germany's defense spending reached €77.8 billion in 2024, surpassing the United Kingdom for the first time since the Cold War.
Comparison of German and UK defense spending over the past decade, showing Germany recently surpassing the UK.
| Year | Country | Defence Spending (Billion USD) | Defence Spending (% of GDP) |
|---|---|---|---|
| 2022 | Germany | 55.76 | |
| 2022 | United Kingdom | 68.46 | |
| 2023 | Germany | 1.8% (shortfall to 2% target: 17bn Euros) | |
| 2023 | United Kingdom | 2.3% (surplus to 2% target: 7bn Euros) | |
| 2024 | Germany | 88.5 (SIPRI) / 97.7 (NATO) | 1.9% (SIPRI) / 2.19% (SIPRI via news) / meets 2% target (NATO) |
| 2024 | United Kingdom | 81.8 (SIPRI) / 82.1 (NATO) | 2.3% (SIPRI & NATO) / 2.35% (SIPRI via news) |
| 2025 | United Kingdom | Planned £59.8 billion (approx. $75.5 billion based on recent exchange rates) | Aims for 2.5% (timeline TBD) |
Inside an anonymous office complex in Berlin's government quarter, planning is underway for a National Security Council within the Federal Chancellery—a structure explicitly modeled on American and French systems—that will coordinate internal and external security policy.
"Merz views Russia's war against Ukraine as a historic rupture requiring a comprehensive revision of foreign and security policies," explained a senior defense ministry official who requested anonymity to discuss sensitive planning. "The old German approach of economic engagement without military hard power is dead."
The chancellor's three-step security strategy involves restoring Germany's capacity for decisive action in foreign and security policy, rebuilding trust with global partners, and defining clear strategic priorities. One immediate priority: providing Ukraine with €3 billion in military assistance.
Defense stocks have already added over $100 billion in market capitalization year-to-date, with analysts projecting a potential "second leg" rally once Berlin unveils its comprehensive National Security Strategy expected in the third quarter of 2025.
Companies positioned to benefit include Rheinmetall, Hensoldt, and Airbus Defence, along with AI-intensive defense startups like Helsing. Meanwhile, civilian aerospace companies face potential talent drain and margin compression as defense priorities dominate.
Testing the Franco-German Partnership
For all the domestic challenges facing his government, Merz appears determined to play a decisive role on the European stage. His first international visit as chancellor will be to Paris tomorrow to meet French President Emmanuel Macron, signaling the importance he places on the Franco-German relationship.
The meeting comes as European leaders grapple with changing geopolitical realities, including uncertain American commitment to NATO and continued Russian aggression on the continent's eastern flank.
"Merz understands that European defense integration is both a security necessity and potentially a market-moving force," said a senior analyst at a major European investment bank. "Watch for language about joint defense-bond issuance following the Paris meeting. Even the hint of such initiatives could trigger a mini safe-asset rally and compress periphery spreads."
Merz has already highlighted inefficiencies in current European defense systems, noting that while NATO's European members operate 178 different weapons systems, the United States has only 30.
European defense faces significant interoperability challenges, particularly with equipment, largely due to the fragmentation of its defense industry. This lack of standardization impacts collaborative efforts, including those aiming for common weapons systems within frameworks like NATO.
Winners and Losers in the New German Paradigm
Investment strategists are rapidly recalibrating their European outlooks to account for Germany's transformation from the eurozone's austerity anchor to potential growth engine.
"We're looking at a German economy that could add 20-30 basis points to nominal GDP growth from 2026 to 2030 solely from infrastructure spending," said the chief economist at a major German bank. "Historical patterns suggest private capital expenditure typically follows German public investment with a 1.2x multiplier. This isn't crowding out—it's crowding in."
Sector prospects vary dramatically under the new regime:
German domestic banks appear well-positioned to benefit from the steeper yield curve and anticipated loan growth, with particular attention on Commerzbank's net interest income.
Construction and materials companies stand to gain from front-loaded infrastructure spending, with analysts favoring firms like HOCHTIEF and Heidelberg Materials that meet stringent ESG requirements for government contracts.
Export champions in the automotive and machinery sectors face headwinds from a potentially stronger euro and escalating trade tensions with the United States, as Merz will likely confront tariff brinkmanship from the Trump administration.
The euro itself could benefit modestly from Germany's fiscal-driven growth premium versus the U.S. dollar, potentially outweighing rate divergence until the European Central Bank adopts a more restrictive stance.
The Road Ahead: Coalition Fragility and Political Risk
Despite Tuesday's eventual confirmation, the parliamentary rejection exposed significant vulnerabilities in Merz's coalition. With at least 18 parliamentarians from his own alliance voting against him in the first round, his government faces challenges in implementing its agenda—particularly constitutional changes that require two-thirds majorities.
The Alternative for Germany, which finished second in February's elections, continues to gain in polls despite being classified as a "right-wing extremist" organization by German intelligence. This classification complicates mainstream coalition arithmetic while energizing protest voters ahead of June's European Parliament elections.
Political analysts outline three primary scenarios for Merz's chancellorship:
- A 60% probability that Merz completes his full term with a somewhat diluted but largely intact fiscal plan.
- A 25% chance of early elections by 2027 following coalition collapse, potentially triggering a 50 basis point spike in Bund yields on risk aversion.
- A 15% likelihood of a grand EU defense-bond package that creates a euro mini-safe-asset rally and compresses periphery spreads.
The Investor's Playbook
For investors seeking to position themselves amidst Germany's political and economic transformation, analysts suggest several strategic approaches:
Long positions in German mid-cap infrastructure installers versus the broader DAX offer leveraged exposure to the anticipated €500 billion capital expenditure surge.
Two-year euro-yen volatility presents an opportunity to hedge against potential Merz-Trump trade tensions that could export 2018-style foreign exchange turbulence.
German green-hydrogen warrants merit consideration as Berlin's industrial power price cap combined with EU state-aid adjustments could accelerate electrolyser demand by 2027.
Alternative Asset Class Index-linked catastrophe bonds may benefit as the climate infrastructure surge raises German reinsurers' float, expanding supply and pushing yields above investment-grade corporates.
A New European Reality Emerges
As Friedrich Merz settles into the chancellery following his turbulent confirmation, Germany stands at an inflection point between its fiscally conservative past and a more muscular, growth-oriented future.
"Merz's stumble-then-surge has fundamentally cracked the spell of German fiscal rectitude," noted a veteran European strategist. "The short-term sell-offs may fade, but the structural shifts—fiscal expansion, defense integration, debt supply—are only beginning to be priced into markets."
For investors, Germany's transformation from fiscal constraint to economic engine represents both challenge and opportunity. Those willing to navigate the inherent volatility rather than retreat from it may discover that the eurozone's once-staid center has become its new growth frontier—with profound implications for European assets and global markets alike.