Merkel victory fails to boost risk assets

A resounding German election victory for Chancellor Merkel and solid flash Markit PMIs couldn't prevent credit markets starting the week on the back foot.

Merkel's CDU/CSU party fell just five seats short of securing an absolute majority in the Bundestag, winning 311 out of the 630 seats in the lower house of parliament. But this was still better than expected and the strongest result for one of the major parties since 1990. Merkel is now in talks to form a grand coalition with the centre-left SPD party, and this now appears the most likely outcome.

A third-term for Merkel will be welcomed by many market participants, though some in the eurozone's periphery may be less enamoured by the result. It remains to be seen whether a grand coalition government will be more amenable to relaxing austerity measures in the region. Comments from Merkel and her finance minister Wolfgang Schaueble suggest otherwise. But we may eventually see some movement on a third bailout for Greece, further assistance for Portugal and faster progress on a banking union.

On the economic front, Markit flash PMIs for China and the eurozone showed the pace of expansion picked up during September. The US also continued to grow, though momentum slowed for the second consecutive month.

Despite the broadly positive political and economic news, spreads gave up ground on Monday. The Markit iTraxx Europe was 1bp wider at 100.25bps, while the Markit iTraxx Crossover underperformed its investment grade sibling, widening by 7bps to trade at 400.5bps. German steel maker ThyssenKrupp was among the main laggards following news that it is struggling to sell part of its loss-making Brazilian business. The company's spreads widened 20bps to 315bps.

It is probable that comments from St Louis Fed President James Bullard, where he said the recent "non-taper" decision was a close call, are still weighing on the market. A speech from New York Fed President William Dudley today was more dovish, but appeared to have little impact on the market. However, several other Fed officials are scheduled to speak this week, and it is possible that they could trigger a change in sentiment.

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