Euro loses ground as French debt concerns weigh and US Dollar recovers

• A US Dollar recovery from three-week lows pushes EUR/USD lower, erasing its earlier gains.
• The Euro remains under pressure from French fiscal worries and wider bond yield spreads.
• With Fed and ECB policy decisions ahead, subdued Eurozone Consumer Confidence puts further pressure on the single currency.

A 0.33% decline in EUR/USD on Thursday has wiped out earlier gains, with the US Dollar (USD) recovering from a three-week low reached during the Asian session. The Euro (EUR) also remains weighed down by political upheaval in France and doubts over the country's fiscal outlook. Having pulled back from an intraday peak of 1.1256, the pair is trading at around 1.1195 at the time of writing.

Investors are shunning French government bonds amid ongoing doubts about France's capacity to restore its public finances and protests on the streets. The resulting sell-off has lifted the benchmark 10-year yield above 5% for the first time since 2002, while widening the spread over German government bond yields.

Bond markets are increasingly pricing in France's fiscal difficulties, according to strategists at Brown Brothers Harriman, who highlight the “French 10-year bond yield premium over Germany … up over 100bps since late February to 175bps, closing in on its 2011 record high of around 190bps.” In their view, if “Italy’s 2018 budget crisis is any guide,” the spread “can widen to about 250bps and drag EUR/USD down to 1.1000.”

For the longer-term outlook, BBH argues that “France’s 2027 presidential election could offer a similar turning point, but only if it produces a government able to deliver credible deficit reduction.” In the absence of such a change, the strategists warn that “French spreads remain vulnerable to further widening, keeping EUR/USD under pressure.”

October's preliminary Eurozone Consumer Confidence reading added to the pressure on the Euro, falling to -17.9 against a forecast of -17 and a previous reading of -16.5.

In the US, falling Treasury yields have not prevented a recovery in the Greenback. Yields continue to retreat from multi-year highs as concerns about AI-related investments weigh on global equities, fuelling demand for government bonds. After touching 5.36% earlier this month, the benchmark 10-year US Treasury yield now stands at around 5.06%.

Having reached an intraday low of 101.45, the US Dollar Index (DXY) is trading at around 101.85. The index measures the Greenback against a basket of six major currencies.

Unchanged interest rates remain the widely expected outcome of the October meetings of both the Federal Reserve (Fed) and the European Central Bank (ECB). Nevertheless, traders still anticipate further rate rises before year-end, as Middle East tensions create energy-related inflation risks that threaten to hold inflation above each central bank's 2% target.

Reports that the US and Israel are weighing renewed strikes against Iran after the US midterm elections have sent oil prices to five-week highs. Supply risks in the Gulf region are also being heightened by continuing Houthi attacks in Saudi Arabia.