The euro fell on Monday to a 17-month low below $1.12, taking its year-to-date losses past 4%, as pressure on French bonds mounted and spread to debt and currency markets across the euro zone.
The euro also fell against the pound sterling, Swiss franc and Japanese yen, as market concerns focused on France, where the government is seeking to pass the 2027 budget to reduce the deficit and rein in record debt levels, amid deep political divisions in parliament and political parties’ preparations for next year’s presidential election.
Bond yield spreads widen
Investors sold French bonds and shifted into German debt, viewed as a safer haven, pushing the gap between French and German government bond yields close to its highest level since the euro zone debt crisis of 2010-2012.
The spread between Italian and German bond yields widened to about 130 basis points, posting its biggest weekly increase since the Covid-19 pandemic crisis. The spread between French and German 10-year bond yields also recorded its sharpest weekly increase in decades, raising concerns that pressure in France’s debt market could spread to other economies in the region.
Kit Juckes, chief foreign-exchange strategist at Société Générale, said bond selling was producing larger moves in assets investors consider more exposed to risk, triggering an accelerating sell-off in the euro.
Weak growth and inflation complicate the European Central Bank’s position
The bond-market turmoil comes as the euro zone economy struggles with weak growth and political uncertainty in several of the region’s largest economies. The party of German Chancellor Friedrich Merz suffered last month its worst regional election defeat in Germany since World War II, while Spanish Prime Minister Pedro Sánchez called for an early election on Monday. Italy is also due to hold an election next year.
With inflation rising because of higher energy costs and bond yields increasing borrowing costs for households and companies, the European Central Bank may face a dilemma in balancing the fight against inflation with calming bond markets.
According to estimates by Bank of America currency strategists, every 10-basis-point increase in the yield spread between French and German bonds may be associated with a roughly 0.4% decline in the euro against the dollar. Goldman Sachs analysts said the impact of yield spreads on the currency increases significantly during periods of acute stress, particularly when German bond yields fall while yields in other euro zone countries rise.
Options markets brace for further euro weakness
The euro remains well above its 20-year low hit in 2022, when the Russian war in Ukraine triggered an energy crisis, but bond-market turmoil has added a new source of pressure on the European currency.
Andreas König, head of global currency strategy at Amundi, said the euro’s weakness this time was not solely linked to the dollar, but also reflected pressure originating in Europe itself.
Data on trader positions from the US Commodity Futures Trading Commission show investors positioned for a further decline in the euro, a trend also visible in the currency options market. Three-month euro hedging contracts fell on Friday to their most bearish levels since 2024, while analysts believe the euro could test $1.10.
Stabilization tools and activity indicators
As the currency’s decline coincides with bond-market turmoil, markets are focusing on the tools policymakers could use to restore stability, particularly if upcoming French elections intensify pressure on markets. The European Central Bank has the Transmission Protection Instrument, which allows it to purchase unlimited amounts of bonds issued by a country facing “unwarranted and disorderly” tightening in financing conditions.
By contrast, business activity in the euro zone expanded in September at its fastest pace in about 3 1/2 years, according to S&P Global data, despite continued weak growth.
Stephen Jen, chief executive and co-chief investment officer at Eurizon SLJ Asset Management, said continued risks of financial contagion in Europe could push the euro lower against the dollar, although the currency already appears relatively undervalued.
