Euro dips below $1.12 during trading

Investors flee French bonds for German safety

France-Germany 10-year spread widens to 1.27 percentage points

Bond market stress spills into currency markets

A one-euro coin rests on top of euro banknotes. [Getty Images]
A one-euro coin rests on top of euro banknotes. [Getty Images]

Falling French bond prices are now shaking the euro itself. As France's standing as a co-anchor of the eurozone alongside Germany comes into question, the common currency has been pushed to its lowest level in 17 months. Markets warn that if the yield spread between Germany — still seen as the backbone of the European economy — and France, which has rattled investors with a sharp rise in borrowing costs, widens further, the euro could slide all the way to $1.10.

The euro fell below $1.12 during trading Saturday (local time), its lowest in 17 months. The currency has lost more than 4 percent of its value this year. It has weakened across the board against the pound, the Swiss franc and the yen as well.

The source of the euro's weakness is France, whose surging bond yields have become a destabilizing force for the currency. Investors have been selling French government bonds and moving into German bonds, seen as a relative safe haven, widening the yield gap between the two countries. The premium investors demand to hold French debt over German bonds has climbed to its highest level since the eurozone fiscal crisis of 2010–2012.

The spread between French and German 10-year government bond yields stood at 1.27 percentage points that day. On Thursday, it had widened to 1.55 percentage points, approaching the 1.81 percentage points recorded during the eurozone debt crisis in November 2011 — the largest gap since the COVID-19 pandemic.

Behind the market turbulence lies France's fiscal and political instability. The French government is pushing to pass a 2027 budget aimed at reducing its deficit and reining in a national debt that has swelled to record levels, but passage is far from certain given a deeply fractured parliament. Political uncertainty has worsened ahead of next year's presidential election, with the surge of far-right candidate Marine Le Pen and a wave of populist campaign pledges. Rising government bond yields in the United States and other major economies have added further pressure on French debt markets.

Inflationary pressure from elevated oil prices is also threatening growth across the 21-nation eurozone. Reuters noted that rising energy prices are intensifying inflation while higher bond yields are increasing borrowing costs for households and businesses. If the euro weakens further, the ECB could face a dilemma between stabilizing prices and calming bond markets, Reuters added.

The bond market stress is now spilling into currency markets. In a recent report, Bank of America estimated that for every additional 10 basis points of widening in the France-Germany yield spread, the euro-dollar exchange rate could fall by about 0.4 percent.

Goldman Sachs also weighed in, saying that while yield spreads normally have little effect on exchange rates, their impact can grow sharply during periods of severe stress. "Spreads are not important for currencies most of the time, but at some point they can become the only thing that matters," the bank said.

Kit Juckes, chief foreign exchange strategist at Societe Generale, said investors are seeing larger moves in assets perceived as even slightly vulnerable. "The selling pressure on the euro is gradually picking up speed," he said, adding that the factors that had kept the euro-dollar rate above key support levels throughout the summer have now faded. He explained that markets had previously expected the energy shock to be short-lived and had priced in the possibility that the United States would engineer a weaker dollar — assumptions that no longer hold.

Andreas König, head of global foreign exchange at Amundi Asset Management, said that while the euro-dollar rate is typically driven more by factors on the dollar side, European dynamics are now playing a role as well.

As the widening France-Germany yield gap feeds euro weakness, markets are watching for a policy response from European authorities. The ECB has the option of activating its Transmission Protection Instrument, which allows it to purchase the bonds of a specific country in effectively unlimited quantities if that country's financial conditions tighten excessively.

Stephen Jen, CEO and co-chief investment officer of Eurizon SLJ Asset Management, said that if the risk of fiscal contagion in Europe is not contained, "the euro-dollar rate could go even lower, even though the euro is already somewhat undervalued."


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