Euro Plummets as French Bond Fears Spread Across Eurozone
The euro is facing renewed pressure as concerns over French bond markets spread across the eurozone. The currency dropped to 17-month lows below $1.12 on Monday, weakening against the British pound, Swiss franc, and Japanese yen. The root of the trouble lies in France, where the government is pushing an unpopular 2027 budget to reduce its deficit and manage record-high debt. Political divisions ahead of next year's presidential election are making investors wary, leading them to sell French bonds and buy safer German debt. The gap between French and German 10-year bond yields has widened to levels not seen since the eurozone debt crisis of 2010-2012.
The broader eurozone is also grappling with political uncertainty, with recent electoral setbacks in Germany and a snap election called in Spain. Italy will also hold elections next year, adding to the instability. Rising inflation due to higher energy costs and increased borrowing expenses for households and corporations are further complicating the situation. The European Central Bank (ECB) now faces a tough choice between combating inflation and stabilizing bond markets.
The French-German bond yield gap saw its largest weekly jump in decades last week, while the Italian-German yield spread hit nearly 130 basis points, the highest since the COVID-19 crisis. Analysts note that the bond sell-off is intensifying euro weakness, particularly against currencies like the yen and Swiss franc. The euro fell almost 4% against the yen in September. Traders are positioning for further declines, with options markets reflecting a bearish outlook.
If fiscal contagion risks persist, the euro could test lower levels, despite already being slightly undervalued. The ECB's Transmission Protection Instrument allows it to buy unlimited bonds to stabilize markets if financing conditions become disorderly. However, analysts do not expect a medium-term turnaround, favoring a dollar overweight position due to stronger US growth and rate prospects.