FXstreet.com (London) - With little in the way of important macroeconomic data on the horizon today, focus is on the German general elections, taking place on Sunday. In the run-up, Angel Merkel’s opponent, Peer Steinbrueck, has so far struggled to gain traction among his core voters on the left. And given Merkel’s huge role in the centre of ongoing Eurozone negotiations, the question is: are German voters ready for the uncertainty of change?

But, as is the nature of the coalition tendencies of the Bundestag, Merkel is most threatened by the weakness of her coalition partners, the classical liberal Free Democratic Party (FDP). In the bellwether Bavarian elections last weekend, the FDP failed to make the 5 percent threshold required to take up seats at the state assembly.

German

Heading into the elections there are three main potential outcomes:

- Existing Merkel-led conservative coalition between her Christian Democratic Union (CDU) and the FDP
- A “Grand Coalition” with the SPD,
- A left wing coalition of the SPD, Greens and Left Party.

A rise in the popularity of the eurosceptic Alternative for Germany (AfD) party, could add to the CDU’s headaches. A poll from German newspaper, Bild, suggests that the anti-euro party has crossed the 5 percent threshold for representation in parliament. The poll has some good news for the CDU-FDP coalition, with a strengthening to 6 percent of the vote. However, combined with the CDU’s 38 percent, this puts the coalition’s combined total at 44 percent – 1 point behind the potential left wing coalition.

The two most likely outcomes remain a continuation of the CDU-FDP coalition, and a Grand Coalition as in 2005-2009. But there are two big factors that could swing things in the direction of a Grand Coalition and away from Merkel – a surge in voter turnout and the breakthrough of the eurosceptic AfD.

The 2009 election saw a record low turnout in the German General elections, at 70.8 percent. Historically, a high electoral turnout has played in the SPD’s favour, at the expense of the smaller FDP and Green parties. Polls suggest that Germany will see a return to historical high levels of voter turnout on Sunday, reducing a fragmenting of the vote and favouring the SPD.

The AfD is balanced on the cusp of the crucial 5 percent of votes required to take up seats in the Bundestag. However, should it achieve its aims, it could be at the expense of Merkel’s centre-right FDP, dispelling any hopes of a continuation of her current coalition.

Status Quo versus Grand Coalition

So what would the electoral outcome mean for the markets? Firstly, in the run up to the elections, Angela Merkel has stuck to her guns in defence of the current policies of German support for struggling periphery Eurozone economies, with conditions attached. This approach has allowed Germany to provide some support to the Eurozone, without periphery countries running up charges on the credit card and expecting Germany to unquestioningly pay the bill at the end of the month. In contrast with Steinbrueck’s proposed policies of European debt mutualisation, with would remove the majority of German power to impose conditions on bailouts, this policy had been received well by German voters.

Steinbrueck has also proposed hard-left positions on banking and financial regulation, calling for a repeal state guarantees for banks, prohibiting highly speculative trades, including high-frequency trading, as well as separating investment banks from deposit banking business. Of particular concern to markets is his vigorous support of the introduction of a version of the Tobin Tax – a levy on financial transactions.

Where implemented in the past, the tax has driven capital flight and exacerbated asset bubbles, with lower trading frequency inhibiting price discovery and driving up volatility. This has been reflected in volatility rises in the front end of the Eurozone bond curves and repos on any renewed talks of a Eurozone-wide tax.

There is some light for markets should a Grand Coalition emerge from the German elections. The SPD currently controls the German upper house, the Bundesrat. As a result, many policies tabled by the centre-right coalition have been blocked by the upper chamber. But in a Grand Alliance, any new legislation would likely avoid these difficulties – this could make a big difference at European level given that Merkel has previously needed to bargain with opposition parties to get the support for votes on the Greek bailout and the European Stability Mechanism. This difference to the length of negotiations may have greater bearing on future European bond market yields than the political leanings of the German coalition Government.