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French-German Bond Spread Widens, Signaling Euro Weakness Ahead of Elections

French-German Bond Spread Widens, Signaling Euro Weakness Ahead of Elections

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Euro (EUR/USD, EUR/GBP) Analysis

  • Threat of political fragmentation in France remains a source of concern
  • Political uncertainties outweigh US CPI reprieve in a busy week for the euro
  • EUR/GBP on track for its largest weekly decline since November
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Threat of Political Fragmentation in France Remains a Source of Concern

European bond markets paint a worrying picture as a move to safety has widened the French-German spread recently, a sign of unease within the bond market. A sharp drop in 10-year bund yields outweighed the recovering French equivalent to raise the spread between the two nations, depicting nervousness on the continent. The euro tends to weaken when bond risk premiums rise across Europe. Another notable bond spread to keep an eye on is the BTP-Bund spread (Italian-German).

German bonds are viewed as safer and prices of such bonds rise when investors pile seek safe harbour from riskier alternatives within the EU – particularly those of Portugal, Italy, Greece and Spain but also France given the recent political developments.

On Friday French parties on the left of the political spectrum are set to reveal the manifesto of their renewed alliance which promises to lower the retirement age, link salaries to inflation and usher in a wealth tax for the rich. The alliance seeks to complicate the political landscape in France after President Macron called for snap elections in reaction to a poor showing during European elections, losing out to Marine le Pen’s right-wing party (National Rally, RN). The first round of elections gets underway on June the 30th with the Euro and CAC 40 expected to weaken in the lead up.

European Bond Markets Reveal Concern

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Source: TradingView, prepared by Richard Snow

Political Uncertainties Outweigh US CPI Reprieve in a Busy Week for the Euro

EUR/USD has a very busy week. The single currency soared after US CPI appeared to return to the disinflationary path to 2% as May inflation data missed estimates (to the downside) but this was cut short by a more hawkish assessment of inflation by the Fed – now seeing only one rate cut this year instead of three anticipated in March this year.

In the end, the political situation in France outmuscled any temporary reprieve provided by US inflation, seeing EUR/USD fall through 1.0724 with ease – now 1.0656 falls into view before the weekly swing low of 1.0600. Next week is relatively quieter on the economic calendar front apart from survey data (ZEW economic sentiment and German consumer sentiment) along with flash PMI data for June.

EUR/USD Weekly Chart

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Source: TradingView, prepared by Richard Snow

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EUR/USD Mixed
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Change in Longs Shorts OI
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EUR/GBP on Track for its Largest Decline Since November

EUR/GBP continued its decline, dropping comfortably below the 0.8472 level of support which previously halted the major descent in April 2021 and has emerged since then as a level of support, until now.

The Friday close will provide a better picture of the longevity of the move but the euro is likely to remain weak as more information and polling information is revealed in the next two weeks. 0.8340 emerges as the next potential level of support with 0.8472 turning from support into resistance.

UK inflation and the Bank of England rate setting meeting are due next week to provide a lot of interest in the pair. Inflation in the UK made encouraging progress in April but was unable to beat lofty estimates. A slight uptick in the economy is unlikely at this point to deter the committee from eying a rate cut later this year as the job market appears to be taking more strain after the latest claimant data rose above 50k, the most since February 2021.

EUR/GBP Weekly Chart

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Source: TradingView, prepared by Richard Snow

--- Written by Richard Snow for DailyFX.com

Contact and follow Richard on Twitter: @RichardSnowFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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