France is Europe’s largest borrower, with non-resident investors holding more than 55% of its total government debt. Their retreat from the French bond market is widening yield spreads relative to German Bunds and could increase the risk of a credit-rating downgrade. Let’s assess the situation and develop a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- France faces a growing risk of a credit-rating downgrade.
- The US labor market remains stronger than the headline figures suggest.
- The US dollar has weathered the impact of the latest jobs report relatively well.
- Short positions can be considered on upswings with targets of 1.1000 and then 1.0850.
Weekly Fundamental Forecast for Euro
Investors are fleeing the sinking French ship, sending the EUR/USD to a 17-month low. Concerns that widening yield spreads between French and German bonds—now at their widest since the peak of the 2012 European debt crisis—could trigger credit-rating downgrades for Paris are prompting investors to pull capital out of the eurozone. What is even more concerning is that yields on Italian, Greek, and Belgian bonds are rising almost as rapidly as those on French debt. This suggests that the contagion is spreading across the eurozone far faster and more broadly than anyone could have anticipated.
France-Germany Bond Yield Spread
Source: Wall Street Journal.
France’s €3.5 trillion bond market is the largest in Europe. Although the country’s public debt, at 117% of GDP, remains below Italy’s 149% and the US’s 126%, more than 55% of French government debt is held by foreign investors. Those investors also have plenty of alternative destinations for their capital. The divergence between French and German bond yields clearly shows this shift.
Bond Yields in Germany and France
Source: Wall Street Journal.
Non-resident investors are fleeing France for two main reasons: concerns that the government may ultimately be unable—or unwilling—to meet its financial obligations. Regardless of whether the political pendulum swings to the right or the left, investors appear increasingly wary of French assets. Instead of narrowing to 5% of GDP, the budget deficit is, on the contrary, heading toward 6%. At the same time, rising borrowing costs and an increasing debt-service burden are making the government’s efforts to reduce the deficit even more difficult.
Against this backdrop, even a weak US jobs report seems like child’s play. In September, US Nonfarm Payrolls increased by just 29,000—nearly three times fewer than economists had forecast—while previous months’ figures were revised down by 60,000. The unemployment rate also climbed to 4.2%. As a result, the probability of a Fed rate hike in October fell to 18%. On paper, this combination should have sent the US dollar tumbling. However, the dollar strengthened.
US Nonfarm Payrolls
Source: Wall Street Journal.
In fact, the Federal Reserve does not need exceptionally strong NFP growth to justify raising interest rates. An aging population and tighter immigration are slowing the expansion of the labor supply. Against this backdrop, even a rise in the labor-force participation rate can be interpreted as evidence of a resilient labor market.
The ECB, by contrast, essentially has its hands tied by the crisis in France. If it continues tightening monetary policy, eurozone bond yields could rise even further, potentially adding fuel to the contagion spreading across the eurozone. That would leave the central bank facing an even greater challenge later, regardless of what measures it might ultimately need to take to safeguard the euro. It is therefore no surprise that even an acceleration in eurozone inflation to a three-year high of 3.8% failed to increase expectations of an October rate hike. Instead, the probability of further tightening fell to just 8%.
Weekly Trading Plan for EUR/USD
The targets of 1.1200 and 1.1000 mentioned in the previous article can be shifted lower. The EUR/USD may fall towards 1.1000, and possibly even 1.0850.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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