We warned on Friday that German Chancellor Angela Merkel faced a 'night of the long knives' in her efforts to bring together the co-called 'Jamaica' coalition of four parties and after a desperate weekend of talks, Bloomberg reports Merkel's efforts at forming a coalition have failed meaning a second election looms and sending the euro sliding.

As Bloomberg reports, talks on forming German Chancellor Angela Merkel’s next government collapsed, throwing the future of Europe’s longest-serving leader into doubt and potentially pointing the world’s fourth-biggest economy toward new elections.

After a 12-hour negotiating session that ended shortly before midnight Sunday, the Free Democratic Party walked out of the exploratory talks, saying the differences with the Green party were too great to bridge.

Merkel has sought for four weeks to enlist the two smaller parties for her fourth-term coalition.

“It’s better not to govern than to govern badly,” FDP head Christian Lindner told reporters in Berlin.

No further coalition talks were scheduled, he said. There was no immediate comment from Merkel.

EURUSD is down aroound 80 pips on the news...

As MINT Partners' Bill Blain noted previously, Germans are not used to multiple elections – and a second vote early next year would be massive negative for Merkel herself – she may even have to stand down if coalition looks like falling. That could be massive shock.

As a result, the prospects for more volatile European peripheral markets, particularly Greece and Italy, are likely to be exacerbated, and we might well see some of the currency and European stock market froth blow away in coming days as the scale of the “German Problem” becomes clearer.

My worst case Germany scenario is a second election early next year, political uncertainty as Mutti Merkel finds herself squeezed out, and a scramble to build a new coalition government in her aftermath.

and a scramble to build a new coalition government in her aftermath. The best case scenario isn’t much better: that Merkel manages to forge a new coalition, but it will be a long drawn out affair and the resulting administration will be vulnerable, weak and fraxious.

These sound like German problems, but they mean the “leader of Europe” is likely to be entirely inward focused in coming months/years.. at a time when the European union will be facing a host of new issues regarding closer union, banking union and reform of the ESM, bailout and QE policies. There will also be new potential crisis points – Italian elections next year, Greece bailout, renewed immigration crisis or a blow-up with Trump. And these are just the known unknowns.

This has profound implications for the so-called French/German axis as it slides towards Paris. We are not going to see a new German government “waste time” on issues like closer EU union, European Banking Union, or critical finance issues like reforming ESM or new approaches on QE and Bailout funds. Forget Wiedemann for ECB president, it’s more likely to another Frenchman (Trichet II) – I’m sure its already underway. In short.. Germany negotiations could get very fraxious while Europe is dragged down in its wake. I doubt the markets have discounted it yet.