French bond contagion fears are rattling the euro
FXE•The euro fell to a 17-month low below $1.12, down more than 4% this year, as concern over French borrowing costs spread across euro-area bond markets. The French-German 10-year yield gap reached its highest since the euro debt crisis, while the Italian-German gap approached 130 basis points.
1. Bond market stress
Investors sold French bonds and bought German debt as France’s government sought to enact an unpopular 2027 budget to reduce its deficit and contain record-high debt. The French-German yield gap last week recorded its biggest weekly jump in decades, and the Italian-German gap rose to nearly 130 basis points, its largest weekly increase since the COVID-19 crisis.
2. Euro under pressure
The euro hit a 17-month low below $1.12 on Monday and fell against sterling, the Swiss franc and the yen. Bank of America strategists estimate that each further 10-basis-point widening in the French-German spread would be associated with a 0.4% fall in euro-dollar. Analysts said the euro could test $1.10, while three-month options positioning was at its most bearish since 2024.
3. Policy and economic risks
The article said a weaker euro could complicate the European Central Bank’s response to rising inflation and higher borrowing costs. The ECB’s Transmission Protection Instrument allows it to buy an unlimited number of bonds from a country experiencing an “unwarranted, disorderly” tightening of financing conditions. Euro zone business activity expanded at its fastest pace in nearly 3-1/2 years in September, S&P Global data showed.
