The mess that is the German elections is by far the dominant trading concern in the euro as we head into the new week. With neither Merkel nor Schroeder winning a clear majority, the prospect of a stalemate and political deadlock has gripped Germany. “Worst of all possible outcomes,” was how one German business executive put it and the European currency has felt the brunt of market disappointment by falling to 1.2104 in early European trade before rebounding slightly.

But we wonder if the market may be over reacting to the news. The “grand coalition” government while cumbersome, may be surprisingly effective as centrist politicians unshackled from their leftist and rightist partners would be free to enact a reform agenda that is clearly the desire of most of the populace.  In fact, a close look at both Schroeder and Merkel's platforms reveals remarkable similarity on key economic points such as the necessity to reduce corporate income tax rates. If anything, parts of Schroeder's agenda are more market friendly, especially in light of the fact that Merkel wants to increase the Value Added Tax while Schroeder actually proposes a lowering the corporate tax burden by a greater amount than Merkel.

The key to euro's stability going forward, however, will be the ability of both politicians to set their ego's aside and work out a reasonable compromise.  At first glance this appears to wishful thinking, as neither Mr. Schroeder not Ms. Merkel were willing to concede the election nor entertain the idea of working together. Such obstinacy  will no doubt only roil the currency markets further and the euro may test 1.2000 figure this week if the market feels the political situation is at an impasse. But if popular pressure on German politicians forces them to work out a quick compromise, the euro may well rebound in the coming days.

Boris Schlossberg is a Senior Currency Strategist at FXCM.