Euro Hits 17-Month Low, Weighed Down by French Debt

French confidence crisis spills over into the euro

The signal had so far been most visible in the bond market. The yield spread between the French OAT and the German Bund at ten years exceeded 150 basis points on Friday before ending the week around 140 points. It widened by 34 points in five sessions, marking its sharpest weekly rise in seventeen years.

This movement, detailed in our article on the lack of confidence in France, reflects the rapid increase in the premium demanded by investors for holding French debt over German debt. The tension now directly affects the single currency, linked to the fear that France’s difficulties will more broadly impact eurozone markets, in a particularly uncertain political context six months before the French presidential election.

In the background, the budget project for 2027 aims to bring the public deficit back to 5% of GDP. The text includes a series of tax increases and spending cuts that still need significant amendments in Parliament. On Friday, Moody's highlighted the uncertainty surrounding its adoption and believes that French political fragmentation is unlikely to resolve quickly.

Dollar Remains Supported by U.S. Interest Rates

The weakness of the euro is not solely explained by France. The dollar remains buoyed by high U.S. yields following the significant correction that hit global bond markets.
The U.S. ten-year Treasury yield reached 5.34% last week, its highest level since 2002, before retreating.

These high levels enhance the relative appeal of the greenback, even though recent U.S. employment figures have reduced short-term expectations for a Federal Reserve rate hike. According to Reuters, the implied probability of a rate increase in October has fallen below 20%, compared to about 64% a week earlier. However, the market still anticipates further tightening later in the year, which helps keep the dollar strong.

Oil Adds Inflationary Pressure

The energy tensions add to this picture. On Monday morning, Brent crude was still around $101.5, despite the G7 tapping into strategic reserves and the recovery of exports from the Middle East.
Persistently high oil prices above $100 fuel inflation fears and help keep long-term interest rates elevated. While not the direct cause of the euro's decline, it strengthens the market environment that currently favors the dollar.

French risk becomes a European concern

The current movement mainly signifies a shift in dimension for investors. Until now, concerns about French public finances were primarily reflected by an increase in the yields of French government bonds and their spread with Germany. The decline of the euro shows that this mistrust is now starting to extend beyond just the French market.

There is now the risk that tensions over French debt could more broadly affect eurozone assets. However, at this point, it is not a scenario comparable to the sovereign debt crisis of 2011-2012. But the combination of high French debt, a fragmented Parliament, and global bond yields at their highest levels in several decades is enough to put European sovereign risk back among the markets' concerns.