Euro Under Pressure as French Bond Turbulence Weighs on ECB Hike Expectations

The euro remains under pressure as turbulence in the French bond market continues to weigh on investor sentiment. The currency is suffering from both a direct fiscal risk premium and a repricing lower in European Central Bank (ECB) rate hike expectations. The ECB's March meeting expectations have dropped from 80 basis points on September 24 to 45 basis points currently, pushing the EUR/USD two-year swap rate differential to -167 basis points. This spread last seen in August 2023 was consistent with EUR/USD trading around 1.08, suggesting further downside potential.

The dollar, meanwhile, is finding support at the start of the week. The euro's weakness and rising global bond yields are contributing to the greenback's strength. The ISM services index eased slightly but remained in expansion territory, with business activity and new orders softening. Employment and order backlogs, along with higher prices paid, helped offset the decline. Markets are comfortable with an October hold from the Federal Reserve, but a December hike remains the base case.

In the UK, attention is focused on Bank of England speakers this week. Catherine Mann, Megan Greene, and Huw Pill, who all voted for hikes in recent meetings, are due to speak. Markets are pricing in a 21 basis point move in November, with a total of 89 basis points expected by June. The spotlight is also on Czech inflation data, with expectations of a rise from 1.9% to 2.5% year-on-year, supporting hawkish bets for the Czech National Bank (CNB).