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 French bond stress spread concerns across the euro area. The French-German yield gap neared its widest since the euro debt crisis, while the Italian-German gap reached almost 130 basis points.
1. Bond stress weighs on euro
Investors have sold French bonds and bought German debt as France seeks to pass an unpopular 2027 budget to lower its deficit and contain record-high debt. The French-German 10-year yield gap saw its biggest weekly jump in decades, and the euro fell against sterling, the Swiss franc and the yen.
2. Contagion concerns grow
The Italian-German yield gap reached almost 130 basis points, its biggest weekly rise since the COVID-19 crisis. Analysts said the euro could test $1.10, and BofA strategists estimate that each further 10-basis-point widening in the French spread against Germany would be associated with a 0.4% fall in euro/dollar.
3. Policy response in focus
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. Euro zone business activity expanded at its fastest pace in nearly 3-1/2 years in September, while analysts warned that uncontained fiscal contagion risk could weigh further on the euro.
