Disastrous regional elections for German chancellor Merz

In focus today

In Sweden, the Origo's Q3 survey on inflation and wage expectations is due. Monthly inflation expectations edged higher in August, mainly at the 1-year horizon, where money market participants' expectations rose to 1.97% from 1.83%. On the 2-year horizon, expectations increased to 2.07% from 2.02%.

The key data releases this week are Wednesday's preliminary September PMIs for most major economies. The euro area will be especially interesting, as strong growth over the summer has made it easier for the ECB to tighten monetary policy, with focus on whether momentum increases further, especially in manufacturing. On Thursday, Norges Bank and the Riksbank announce their rate decisions. In Norway, market pricing and consensus are close to 50/50 between a hike and a hold. We expect Norges Bank to keep the policy rate unchanged at 4.25%, but signal that it may be necessary to raise the policy rate further. In Sweden, we expect a hawkish hold at 1.75%, with the Riksbank likely to signal a Q4 hike.

Economic and market news

What happened overnight

In Germany, Chancellor Merz's CDU party was beaten markedly in two regional elections on Sunday. According to preliminary results, the party fell to 4.9% in Mecklenburg-Vorpommern, missing the 5% threshold, and 18.8% in Berlin. The far-right AfD came out ahead of the social democratic SPD in Mecklenburg-Vorpommern, winning 38.2% against 35.5%, although the AfD is unlikely to enter government, as the other parties have ruled out a coalition with it. Die Linke won the Berlin state election with 25.7%. Merz called the north-eastern state result a "disaster" but said he will stay on as Chancellor and press ahead with his reform agenda. The pressure on Merz nonetheless increases further, raising the likelihood of a change of Chancellor and reinforcing a slowly building political-risk-premium narrative, though a breakdown of the federal coalition still looks unlikely for the time being.

In commodities, Brent crude is trading below USD 102/bbl this morning, extending last week's decline due to hopes for renewed US-Iran diplomacy talks. The US and Iran exchanged new threats over the weekend, but Trump said he may meet Iran's president at this week's UN General Assembly. Tensions remain elevated after the Houthis said they attacked sensitive sites in Riyadh and an Aramco facility in Yanbu over the weekend, but higher shipments through the Strait of Hormuz and a partial recovery in exports from Saudi Arabia have reduced the immediate geopolitical risk premium.

What happened over the weekend

In geopolitics, an US-Denmark-Greenland agreement is expected to be signed on the sidelines of the UN General Assembly in New York this week, according to press statements from the prime ministers of Denmark and Greenland and social media posts from President Trump and other US officials. Trump's Truth Social post said the deal "gives the United States permanent control over security, and all other needs, in Greenland, completely addressing ALL of our many US concerns." Denmark said the deal recognised Denmark's sovereignty and territorial integrity as well as the Greenlandic people's right to self-determination. The agreement appears to largely confirm the status quo but could allow for a political deescalation of the issue. Yet, the details are very scarce, and a final deal likely needs to be ratified in the three countries' parliaments.

In the Euro area, inflation expectations in the ECB's consumer survey were slightly higher in August. The 1Y median expectation rose to 3.0% y/y, while the 3Y median expectation increased to 2.9% y/y. After trending lower since May, expectations now appear to have stabilised around 3%. The end of the declining trend is likely to be interpreted hawkishly on the margin by the ECB. 

In the US, industrial production and manufacturing output came in below expectations in August. Industrial production was unchanged m/m (cons.: 0.3% m/m, prior: 0.2% m/m), while manufacturing output fell 0.3% m/m (cons.: 0.3% m/m, prior: 0.2% m/m), ending seven consecutive months of increases. The decline in manufacturing output was led by durable goods, and the print points to a more moderate outlook for manufacturing activity after a strong first half of the year, amid higher energy prices and rising interest rates. Capacity utilisation was unchanged at 76.3% in August, slightly below expectations of 76.4% and still well below its long-run average of 79.4%.

In China, the central bank kept its Loan Prime Rates (LPRs) unchanged, leaving the 1-year LPR at 3.0% and the 5-year LPR at 3.5%, in line with expectations. The steady LPRs underscore how China currently prefers to use fiscal policy to support the economy.

Equities: Last week's equity market offered a useful illustration of how we believe the remainder of 2026 could unfold. The week split neatly into two phases. Initially, the renewed rise in oil prices undermined risk appetite, with defensives, minimum volatility and value outperforming. As oil subsequently retreated, equities recovered and ended the week marginally higher. Leadership also reversed, with cyclicals, growth, momentum and large caps outperforming towards the end of the week. Health Care and Technology were the strongest sectors overall.

Absent renewed disruption around the Strait of Hormuz, and particularly if a path towards a solution begins to emerge, lower oil and energy prices could become a powerful catalyst for a sharp recovery in risk appetite. Under that scenario, equities could easily gain another 5 to 10% over the next three months, even without any improvement in the macro backdrop. We would expect such a move to be led by Technology and, at the factor level, growth, quality and cyclical quality, while the US and emerging markets should lead regionally.

There were several political headlines over the weekend, but the more important market impulse this morning is that oil is down another couple of percentage points. Asian equities are extending their advance, while both European and US futures are trading higher.

FI and FX: Treasuries sold off on Friday in a bear-flattening move, extending the post-FOMC repricing. Front-end and belly yields rose 7-8bp on the day, with the 2Y closing at 4.74% - its highest level since July 2024. European rates also rose on Friday, in a bear-flattening move driven by a combination of rising energy prices and a dramatic deterioration in French sovereign risk. The Bund 2Y rose 5-6bp to 3.28%, the Bund 10Y rose 5bp to 3.52%. EUR/USD consolidated below 1.15 on Friday, as energy prices remained relatively little changed. As for the SEK, it continues to struggle with EUR/SEK currently trading at one-year highs around 11.30. EUR/NOK remains unchanged around 10.80.