My quick take:
Market reaction to Sunday’s German election was muted. I was a little surprised that the euro and DAX did not do better given the worst case scenario (a SPD-Green-Left coalition that would have raised taxes and worsened the energy crisis) has been avoided. It is possible that the market is skeptical like me that a new government will be formed any time soon.
I think we can safely rule out another CDU/SPD grand coalition at this point. This is because while SPD won, it won by much less than the polls predicted. This means CDU might prefer going to another election over becoming a junior coalition partner.
This leaves only two possibilities:
A: SPD/Green/FDP
B: CDU/Green/FDP.
Which of the two is more likely depends on which configuration creates more room to accommodate potentially difficult co-existence between the Green and FDP. Neither outcome will be easy to achieve, especially given the growing rivalry between Habeck and Baerbock inside the Green and the blame game within the CDU for the election loss that will weaken Laschet’s bargaining position in coalition negotiation.
Prolong political uncertainty is market negative, as it is likely to weigh on business and consumer confidence. To the extent that the fragmentation of German politics will likely weaken the ability of Germany to unite Europe during crises in the future (like Merkel has done so many times over the past decade), this election outcome should be viewed as long-term negative for the Euro and the Eurozone project.
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