Euro Weakens as French Fiscal Risks and ECB Vulnerability Weigh

The euro is under pressure as investors reassess French fiscal risks, driving broad euro weakness in forex markets. The European Central Bank's tightening cycle is more vulnerable to adjustments than the Federal Reserve's, which is keeping the EUR/USD pair under pressure. Meanwhile, Brazilian assets are expected to rally following the results of Sunday's presidential election, where Flavio Bolsonaro gained 47% of the vote compared to President Lula's 45%.

The US dollar index (DXY) is reaching new highs for the year, propelled by the euro's sell-off, which makes up 58% of the DXY basket. The next target for the DXY is 102.85. Despite Friday's softer September jobs data, the market remains comfortable with the Fed's policy outlook of unchanged rates in late October and a hike in December. This week's focus will be on the ISM services data and the FOMC minutes, both of which are expected to support the dollar.

All eyes are on French debt this week, with the euro breaking lower overnight due to broad euro selling. The risk premium for the euro is increasing due to fiscal woes, with EUR/USD targeting 1.1100/1120, and a potential extension to the 1.10 area. The ECB faces a challenging task of balancing tough talk on inflation while being prepared to intervene if the French debt sell-off escalates.

In Central and Eastern Europe, inflation data will be in focus this week. Turkey’s September inflation is expected to edge up, while Czech inflation is due tomorrow, with expectations of a rise driven by higher fuel prices. Hungarian inflation is also expected to climb, largely due to fuel prices. The Czech koruna is favored within the region due to higher inflation expectations and a more hawkish stance from the Czech National Bank.

Brazilian assets are set to rally following the presidential election results, with Bolsonaro running on a ticket of fiscal austerity and deregulation. The currency and bond market are expected to rally, but the stronger dollar environment and surging US Treasury yields may create a more difficult external environment for emerging market currencies. USD/BRL could open near 5.10, with a move back to the lows of the year at 4.90 considered too aggressive.