“When you turn an election into a three-ring circus, there is the possibility the dancing bear will win..”

After Sunday night's shocking failure by Merkel to from a government (triggered by the Free Democrats walking out due to irreconcilable differences on refugee policy, energy policy and tax policy) the FT was quick to conclude that "Merkel faces worst political crisis of her career." And while Merkel is certainly in hot water, a more appropriate question is what's next for Germany.

According to UBS - which has a clear interest in preserving the calm - there are four possible scenarios:

First, Chancellor Merkel could try to re-engage with the FDP and bring it back to the table and start coalition talks.

Second, the CDU/CSU could try to approach the SPD to form a grand coalition, which would have an absolute majority. However, the SPD has repeatedly mentioned (again last night) that it is not willing to go for this option and prefers to be in opposition.

If these two options do not work (which would be the first time in post-war Germany), either a minority government (Chancellor Merkel dismissed this option on election night) or new elections could follow.

The procedure for new elections, however, involves several steps, as outlined below.

The current (grand coalition) government remains in place until a new government is formed, i.e. until parliament votes on a candidate for chancellorship proposed by the Federal President (for which there is no time limit). If no workable coalition can be found, the way towards new elections involves many steps as reported in the press. The Federal President Steinmeier must propose a candidate for chancellorship (normally, this is the candidate put forth by a majority coalition, but he is free to choose others) and parliament would vote on this candidate. If the Federal President's candidate does not obtain an absolute majority (which has never happened before in post-war Germany), parliament has 14 days to propose and vote on a candidate in a second round. If in this second round of voting no candidate obtains an absolute majority, there is a third round of voting where a candidate can be voted as chancellor with only a relative majority. If a candidate is voted with only a relative majority, the Federal President can either appoint the candidate as chancellor (implying a minority government) or dissolve parliament. In the latter case, new elections have to take place 60 days after parliament has been dissolved. At this stage, however, it is unclear whether new elections would

produce a significantly different result compared to the last election.

To be sure, UBS' view is that no matter how bleak Merke's "crisis" looks, the fallout will likely be limited, to wit:

"even though the EUR dipped on the breakdown of the Jamaica talks, the broader market reaction has been contained. With Merkel's acting government remaining in place, big political decisions on Brexit and EU issues anytime soon appear more difficult, including at the December Euro summit. If the grand coalition no longer remains an option, this could, in our view, lead to some risk-off pressure, the negative fallout for periphery markets (and a wider risk-off) should be contained."

Perhaps: for UBS' "calm and collected" outcome to be validated, the ECB may be forced to become more actively engaged in micromanaging risk again, something few have discussed yet.

Meanwhile, as things heat up, there has been a bararge of headlines, among which:

GERMAN PRESIDENT URGES PARTIES TO FIND DEAL TO AVOID NEW VOTE

STEINMEIER: GERMAN PARTIES SHOULDN'T RETURN MANDATE TO VOTERS

SPD'S SCHULZ ASSUMES THERE WILL BE A NEW ELECTION

SPD'S SCHULZ ALSO REJECTS GRAND COALITION WITHOUT MERKEL

LINDNER: NO GERMAN POLICY CHANGE POSSIBLE WITH GREENS, CDU, CSU

These headline confirm that one of the 4 options highlighted by UBS has been ruled out for Merkel. The SPD’s Martin Schulz, who performed poorly at the last election, has rejected the idea of re-forming the Grand Coalition by lending his party’s support to Merkel’s government. He has also said that he assumes that there will indeed be a new election, as Citi adds.

Another option seemed to be ruled out too, as FDP leader Lindner suggested as recently as a few minutes ago that common ground cannot be found – so the Jamaica coaltion government still looks off the cards, although Merkel will no doubt be hoping to form some sort of minority government.

At the moment, this all does seem to be pointing towards new elections for Germany. Citi Economics explain:

Under Art. 63 of the German constitution, the Bundestag would first have to elect a new Chancellor upon proposal by the President, which is possible with a relative majority after 14 days of nobody getting an absolute majority. The President can then within 7 days confirm the winner or dissolve Parliament, which would lead to early elections within 60 days […] It could start soon and elections could be held probably in January at the earliest”.

In any event, for a more practical and unbiased take on what happens next in Germany, we turn to Mint's Bill Blain, who back in September correctly predicted just this outcome, when all of his far better paid peers said the odds of a negotiation failure are negligible. Here is Bill Blain with his take on "What's next for the Germans."

Ha. Macron must be creasing himself with laughter… I bet he struggled to keep a straight face as he commiserated with the (soon to depart?) Angela… Funny how the good news is all French these days… And in Harare/Berlin an elderly befuddled leader doesn’t know if they are coming or going. Despite triggering of Gotterdammerung, market reaction to the German electoral talks collapse is curiously muted – the Euro taken a minor spanking, and stock markets a tad-let lower. I’m not really surprised at the lack of fireworks. Markets have become blasé about political noise – understanding how easy it is to over-react. It’s going to be a short holiday week, its year-end and folk are protecting what they’ve made this year. As one heads westwards, interest or cares in German politics diminishes pretty quickly? It’s just something that happens – Isn’t it? Er.. actually…. what’s going on in Berlin is pretty important stuff. Or, at least it should be… I’m trying to get my head round what happened and what cracked – it’s important to understand the collapse to work out what happens next… Last week chums in Berlin assured me it was a just a matter of time before Muti Merkel signed a new coalition deal. Over the weekend it all came apart. It would seem the Greens and the Liberals just didn’t fancy the compromises and potential electoral suicide pact that underlies being Merkel’s stooges. Back in September I warned the coalition process was likely to be far more difficult and fraxious than the market expected. I even said the chances of an outright failure to agree were as high as 50% – check out Porridge Extra Sept 25th. I was told I was a know nothing idiot (not disputing it!). But, I didn’t expect crisis this soon. My worst case was a second election triggered early next year – and Merkel squeezed out. I’m going to spend some time talking around contacts and putting together some new scenarios, but I’m struggling to find much upside. I suspect Merkel will have to go. The outlook is for a complete re-jig in German politics; out with the old, and in with something new(er). New coalition discussions or an election will be equally drawn out. A new administration could be vulnerable, weak and uncertain as the “leader of Europe” is entirely inward focused in coming months/years. Don’t underestimate the sentiment effects on Europe. Who is going to lead the agenda re closer union, banking union and reform of the ESM, bailout and QE policies? And what about dealing with Putin, Italian elections next year, the inevitable Greece bailout blow up, renewed immigration crisis, Brexit, a blow-up with Trump, and a Frenchman to replace Draghi at the helm of the ECB looking increasingly nailed-on. And I reckon the young emperor in Paris, Macron, is going to be disappointed – if he see this as his chance to re-establish French leadership at the core of Europe, he may be well disappointed. If Berlin doesn’t care.. who’s interested? Perhaps not – Yoorp is a long-game.

Finally, with Merkel now fighting for her career and political survival, the EUR has yet to skip a beat, and remains solidly stuck to the 1.1770 strange attractor.