French bond contagion fears are rattling the euro
TLT•The euro fell below $1.12 to a 17-month low, down more than 4% this year, as rising French borrowing costs and widening bond-yield gaps fueled contagion fears. The French-German 10-year yield gap reached its widest since the 2010-2012 euro debt crisis, while the Italian-German gap approached 130 basis points.
1. Bond stress weighs on euro
Investors have been selling French bonds and buying German debt as France seeks to pass an unpopular 2027 budget to reduce its deficit and contain record-high debt. The French-German 10-year yield gap saw its biggest weekly jump in decades, while the Italian-German gap rose to almost 130 basis points, its biggest weekly increase since the COVID-19 crisis.
2. Further weakness possible
Analysts said the euro could test $1.10, and options positioning was the most bearish since 2024. Bank of America strategists estimated that each additional 10-basis-point widening in the French spread against Germany would be associated with a 0.4% fall in euro/dollar. The European Central Bank’s Transmission Protection Instrument allows it to buy an unlimited number of bonds from a country facing an “unwarranted, disorderly” tightening of financing conditions.
