"the Thalmor blitzkrieg the Imperial City, then the Empire slaps the piss out of the overextended Thalmor and completely routs them, and then Empire surrenders to the devastated Thalmor for reasons of narrative contrivance,"

I'm pretty sure the idea is that the Aldmeri Dominion was believed to have plenty of reserve strength to carry on the war, and that pushing them back basically left the Empire with dregs. Like they were convinced that if the war continued they would just slowly lose. So they used what bargaining power they felt they had to negotiate a conditional surrender, intended to give them the time to rebuild strength (maybe even operating under the idea of human birth rates significantly outpacing elven ones, resulting in a faster recovery in the Empire than in the Dominion)