Summary:

• Angela Merkel concedes defeat as she fails to form a new government over the weekend
• Three scenarios for German chancellor after coalition talks collapsed
• Euro grinds decisively lower, JPY increases on a broader tone of risk aversion

German chancellor Angela Merkel had to concede defeat over the weekend as she failed to forge a new government after the election which took place roughly two months ago. Merkel said that she regretted a FDP’s decision to pull out of coalition talks on forming a government as immigration was reportedly the main sticking point. Chancellor also added that she would inform German president about the debacle of coalition talks. It’s worth underlining remarks of FDP leader Christian Lindner who claimed that “there was no progress but rather there were setbacks because targeted compromises were questioned”. “The four discussion partners have no common vision for modernization of the country or common basis of trust”, Mr Lindner added in the early hours of Monday.

That kind of scenario extends a political stalemate suggesting that Merkel could run out of power to create a new coalition government. Having said that one could conclude that she has three options remaining on the table. The first one is renewing her coalition deal with the center-left Social Democrats (SPD), however it appears to be very unlikely as this option has been ruled out repeatedly by the SPD. The second scenario could be to govern as a minority government nevertheless it would also mean limited grip on power and therefore quite a weak position in implementing new reforms. The last but not least option is a new election, this option seems to be the worst from a financial markets’ point of view prolonging political tailspin well into 2018 as a possible election could take place in spring. However, even if this scenario materializes, it would result in the same outcome.

The EURJPY slides following a setback in German coalition talks. Source: xStation5

As a result the euro opened broadly lower in the Sunday’s evening nearing 1.1700 against the US dollar. Beside the EURUSD it’s also worth paying attention to the EURJPY as the pair is hovering around its important support line placed at 131.50. Once this level is broken, it could bring about deeper drops toward 128. Moreover, the Japanese currency is strengthening in the morning on the back of fading risk appetite as Asian stock markets are falling just a while before the close except the Shanghai Composite (CHNComp) which is trading marginally higher.