Market Extra: Merkel’s coalition talks fall apart — here’s what analysts think will happen next

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Germany is facing political uncertainty as the week kicks off, after talks to form a coalition government collapsed on Sunday.

Reports that the negotiations broke down whacked the euro, sending the shared currency EURUSD, -0.0763%  down toward the $1.17 level, but it has bounced back and spent some time back above $1.18.

Germany’s DAX stock benchmark DAX, +0.21%  was modestly higher after morning losses faded, while S&P 500 futures ESZ7, -0.06%  were inching down.

Politicians in Europe’s largest economy had been attempting to put together a so-called Jamaica coalition, meaning a three-way alliance between Chancellor Angela Merkel’s conservative Christian Democrats (CDU), the liberal Free Democratic Party (FDP) and the Green Party.

The “Jamaica” name stems from the respective parties’ black, yellow and green colors, matching the Caribbean nation’s flag. The Social Democratic Party (SPD)—the CDU’s junior partner in Germany’s last coalition government—wasn’t part of that possible governing team, and neither was the Alternative for Germany (AFD), a far-right party.

The general election two months ago handed Merkel’s CDU alliance with its worst result since 1949.

Merkel might try to lead a minority government, though that would mean holding negotiations with opposition parties for all bills in parliament. There have been reports that the FDP would support such a minority arrangement, and that news may have boosted the euro. German President Frank-Walter Steinmeier was scheduled to make a statement on Monday at 8:30 a.m. Eastern Time.

Read: How Merkel’s choice of partner could set the tone for the euro

And see: 5 things you don’t know about Germany’s Angela Merkel

What should investors watch for next, and why is the euro erasing losses? Here are some of the initial reactions from analysts:

• “There are, I suppose, four plausible outcomes in Germany. The first is that the Jamaica coalition is revived, which seems unlikely. The second is that the CDU/SPD coalition is revived but that seemed to be what the electorate were unhappy with at the election. The other two, fresh elections or the CDU ruling as a minority government, are untried in the modern era. The only real enthusiasts for new elections are the AFD, who might build on their strong showing last time around.

Maybe what markets are saying overall is that minority government or further coalition talks are fine, as long as the economy is growing. As for the FX conclusion, the EUR/USD $1.1480-$1.1880 range is holding. If we can get positioning right and relative yield trends moving in the euro’s favor, we can break higher.”—Kit Juckes, macro strategist at Société Générale

•“According to Bild, the FDP said they would support [a] minority government. Thus, the ramp in the EURUSD. If Merkel does not have to call new elections EURUSD could pop more on relief. So far $1.1800 caps the move.”—Boris Schlossberg, managing director of FX strategy for BK Asset Management, in a tweet

“If anyone can rule a minority government, surely it’s the consensus-building Angela Merkel? Also, Merkel’s own CDU party would surely be mad not to keep her as leader if there is another election due to her personal popularity across the country. This is why we think that the euro, German bond yields and the DAX have all managed to recover even in the midst of German political uncertainty.”—Kathleen Brooks, research director at City Index

• “Uncertainty is poison for the economy. But the collapse of the Jamaica exploratory talks can hardly be a shock for businesses after four agonizing weeks of negotiations. Furthermore, the German economy is currently in robust shape.…I continue to expect growth of 2 point something this year.”—Joerg Kraemer, Commerzbank chief economist, according to a Reuters report

• “Likely to weigh on risk this morning is the government coalition talks in Germany, which many anticipated would take a while to come together. [They] appear to have collapsed completely and now raise the prospect that we could see new elections, as well as continued political uncertainty and deadlock in Europe’s largest economy.”—Michael Hewson, chief market analyst at CMC Markets UK

• “Political uncertainty is never a positive driver for a currency and even though the single currency enjoyed strong gains last week this fresh turn of events is now weighing down on its outlook.”—Konstantinos Anthis, ADS Securities analyst