German election: 'Jamaica Coalition' most likely scenario

After the disappointing results by both CDU's Merkel and SPD leader Schulz, the latter told supporters that a coalition with Angela Merkel is not an option.

The implications of Schulz decision means that Merkel's CDU is expected to try to form a coalition with the liberals and the Greens, what has been called the "Jamaica Coalition" due to the colour of the parties matching the countries' flag. 

The Independent UK notes: "Such a coalition has not been formed at German national level before – though it does sometimes occur in Germany's state parliaments.  Alternatively, the CDU could try and form a minority government, though Merkel is thought to favour the Jamaica option."

As the political landscape stands, Germany is unlikely to overly focus on EU much-needed reforms until coalition talks are over, which may take months to reach a consolidated position. 

Scenarios 

Clear victory by Merkel: This is more of a same kind of situation in Germany and Eurozone. Approving bailout packages will be easy; there will be more room for Eurozone financial integration. The idea of the European monetary fund will gather traction. Finance Minister Wolfgang Schaeuble wants to run fiscal surpluses every year until 2020 and has only vaguely hinted at tax cuts. So there is little scope for fiscal reflation…

Impact on EUR/USD: mildly positive, Focus would shift to the ECB.  EUR/USD could rally sharply if Merkel changes her stance following a clear vitory and talks about reflating the economy.

Tight victory by Merkel: Polls suggest Merkel will be short of a parliamentary majority in the Bundestag and will need weeks, if not months, to form a new coalition government.

A small majority for Merkel would make her vulnerable during if there’s a new crisis in the Eurozone.

Impact on EUR: A minor initial sell-off likely. Next move depends on the sound bites - if in support of reflationary policies, EUR would rally.

Schulz win: Schulz has promised to cut taxes for anyone earning less than 60,000 euros - a measure that would benefit nine out of 10 German workers - and to reduce social security contributions for those earning up to 15,000 euros a year. Schulz also wants to spend 30 billion euros more on public investment by 2021. He wants to raise taxes for top earners.

Impact on EUR: An Intraday sell-off could be followed by a sharp rebound and rally to 1.24 handle in the subsequent days, especially if the new Chancellor talks about delivering tax cuts and public spending.