Euro Rebound Driven by Falling French Bond Yields

The euro bounced back on Tuesday after hitting a 17-month low the previous day, as a rebound in French government bonds eased concerns about euro zone debt markets. The euro gained 0.5% to $1.127, recovering from its drop to $1.116 on Monday. This helped weaken the dollar index by 0.4% to 101.75, after it reached an 18-month high of 102.53 the day before.

Bond markets worldwide have faced turbulence in recent months due to expectations of aggressive central bank rate hikes, driven by rising energy prices from the US-Israeli conflict with Iran, as well as worries over high borrowing costs. French debt has been particularly affected, with politicians struggling to control the budget deficit ahead of the 2027 election, which contributed to Monday's euro decline. The announcement of a snap election in Spain added to the challenges.

A drop in energy prices on Tuesday supported a rally in French bonds, with the key 10-year yield falling by more than 0.1 percentage points. This improvement helped stabilize the euro. Commerzbank FX analyst Volkmar Baur noted that market jitters have eased with the current yields on French government bonds, but warned that instability could return at any time.

The dollar's decline provided some relief to other currencies, with the pound rising 0.4% to $1.328. However, the dollar gained 0.1% against the yen to 158.07. The Bank of Japan may signal this month that underlying inflation has met its 2% target, suggesting potential interest rate hikes in the coming months.

The US dollar's strength has persisted despite reduced expectations for a Federal Reserve rate hike in October, following weaker-than-expected US jobs data. Investors still anticipate further policy tightening, with the CME FedWatch Tool indicating an 85% chance of at least one hike by December. ING currency strategist Francesco Pesole noted that the euro's weakness and rising global bond yields continue to influence markets.