The desk believes that the current vulnerabilities in eurozone bond markets, particularly surrounding France's fiscal situation and upcoming elections, could lead to wider spreads and a weaker EUR in the near term. Per the full note from ing-think, these dynamics are compounded by rising interest rate volatility and potential correlations with energy prices, creating a challenging environment for the EUR/USD pair. Consensus forecasts among firms currently suggest a range for EUR/USD in the coming months, indicating a cautious outlook as these factors unfold.
What the desk is arguing
The desk argues that the precarious fiscal conditions and election risks in the eurozone, especially in France, are likely to widen bond spreads and pressure the euro. According to the ing-think commentary, any potential for stabilization hinges significantly on credible French fiscal consolidation plans.
This perspective is further supported by the observation that higher interest rate volatility has historically contributed to wider sovereign spreads. Notably, during periods of geopolitical tension, such as the recent Middle Eastern unrest, we saw a pronounced relationship between bond spreads and fluctuating energy prices.
Where it sits in our coverage
Current consensus for EUR/USD targets shows a median forecast for December 2026 at 1.1500, with significant variation across firms. Key targets include: - Rabobank: 1.1800 - Commerzbank: 1.2200 - UBS: 1.1600
Our desk’s view aligns with the upper end of the spectrum, which suggests that market participants are bracing for continued volatility and potential weakness in the euro.
How other firms see it
Various firms are aligned in their cautious stance towards EUR/USD amidst the mentioned risks—Nomura and HSBC also show targets inline with the expectation of a weaker euro. Conversely, Investec is slightly more optimistic, positioning for a less severe depreciation.
Additionally, movements in the EUR/USD pair will likely be reflective of broader trends in bond yields and ECB monetary policy adjustments, underscoring the interconnectedness of these factors.
01High fiscal strains in France pose significant risks to eurozone bond spreads.
02Upcoming elections in several countries could further complicate these dynamics.
03Market responses to geopolitical tensions are increasingly correlating with energy price fluctuations.
04Consensus forecasts indicate a cautious outlook for EUR, with targets ranging from 1.1162 to 1.2200.
Market implications
Traders should closely monitor the upcoming electoral landscape in Europe, particularly the Spanish and Italian elections. Any shifts in fiscal policy or significant moves in bond spreads could directly influence EUR/USD performance.
Risks to this view
The primary risks to this outlook include a significant improvement in French fiscal health or unexpected stability in European political outcomes. Should these scenarios play out, they could lead to tightening spreads and a stronger euro.
Articles European bond spreads in a duel with the ‘Bad’ Published 10:27 Rates Translate Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Fiscal strains and election risks are putting eurozone bonds to the test. France is the key fault line, while Bunds’ safe-haven appeal masks mounting supply pressures. We see a turbulent first half of 2027, and any relief hinges on a credible path to French fiscal consolidation Benjamin Schroeder Credible French fiscal consolidation plans could bring relief to eurozone government bond markets European government bond markets – in a duel with the “Bad” European government bond spreads have returned to the market’s focus.
Importantly, spread moves are not purely idiosyncratic country stories. They also reflect broader risk sentiment, and higher interest rate volatility generally pushes spreads wider. At the onset of the Middle East turmoil, for instance, we saw sovereign spreads become more closely correlated with energy prices and expectations for European Central Bank rate hikes.
But high deficits – the “Bad”– and existing fiscal imbalances have made some countries more vulnerable than others, and these factors are increasingly shaping the dynamics of sovereign spreads. The “Bad” has re-entered the scene and is once again dominating the narrative in parts of the European government bond market. While France is already being singled out as a risk factor with the potential to change the broader outlook for European sovereign debt, Europe’s busy election calendar suggests that idiosyncratic drivers could become more important overall.
Spain goes to the polls later this month, and Italy will have to hold legislative elections before the end of next year. Finland will also hold parliamentary elections, while Germany faces elections in five federal states. And that is just to name the most prominent.
As markets navigate these political and fiscal risks, we expect spreads to remain at wider levels through much of the first half of the year. Markets have reordered the EMU countries over the years, and have now singled out France Source: IMF, Refinitiv, ING "> Source: IMF, Refinitiv, ING France – Facing the very “Bad”, the one that could change it all Moody’s recently affirmed France’s last remaining double-A rating but maintained a negative outlook. The underlying assumption is that a 2027 budget containing at least some fiscal consolidation will eventually pass, even if this requires the use of a decree.
That would represent a step in the right direction and could offer French government bond spreads some welcome relief going into the new year. Beyond that, however, a “significant and sustained fiscal effort” will still be required. The outlook is clouded by the 2027 presidential election, with the two voting rounds on 18 April and 2 May.
The far-right’s Marine Le Pen, the current leading contender, could subsequently call snap legislative elections in the summer in an attempt to break the parliamentary deadlock. The benign scenario would be one in which Le Pen wins and follows through on her promises of fiscal consolidation. In that case, spreads could return towards levels seen before September, and France could conceivably trade tighter than Italy again.
There is, however, still a long way to go before such an outcome can be taken for granted. If Italy is the yardstick for a proper crisis, there is still room for escalation Source: Refinitiv, ING "> Source: Refinitiv, ING The consolidation plans presented so far by Le Pen appear unrealistic, while the French public does not yet seem prepared to support the scale of adjustment that would ultimately be required. Against that backdrop, the market is likely to continue demanding a sizeable political risk premium.
In the absence of positive catalysts, we see a 10-year OAT-Bund spread in the area of 150bp as a floor during the period of electoral uncertainty. The tail risk is that public discontent instead translates into stronger support for the far left and Jean-Luc Mélenchon, whose proposals have included highly controversial ideas such as cancelling French debt held by the Bank of France. A greater probability being attached to such an outcome could push the 10-year OAT-Bund spread beyond 200bp.
More broadly, the absence of a credible multi-year consolidation plan, combined with the possibility of another hung parliament, would leave the door open to further sovereign rating downgrades, and not just from Moody’s. In an unscheduled update, Fitch only recently lowered the outlook of France’s A+ rating to negative. Under such circumstances, spreads could remain noticeably above 100bp even once the immediate electoral uncertainty has passed.
That said, we believe current spread levels already extend beyond what fundamentals alone would imply. The market is effectively pricing French debt as though it were already rated BBB. But prolonged and exceptionally high country-specific uncertainty, combined with elevated volatility in broader interest-rate markets, keeps valuations unattractive for many investors.
One big risk is that structural foreign investors, which have historically been attracted by France's large, liquid bond market, start abandoning the credit. While data through August do not show any larger shifts, Japanese investors, for instance, have already shown themselves to be sensitive to French election risk in the past. French has a large foreign investor base which has looked fickle around elections Source: Bank of Spain, Bank of Japan, ING "> Source: Bank of Spain, Bank of Japan, ING The ECB can cap spreads, but does it want to?
In theory, the European Central Bank has both the instruments and the firepower to rein in sovereign spreads. But as long as the turmoil remains largely contained to France, we think the central bank will be inclined to let market mechanisms play out, thereby maintaining pressure on French politics to address the underlying fiscal issues. The ECB has historically been careful to avoid creating the impression of moral hazard.
If needed, the first and least targeted response would be to dial back hawkishness or even halt the tightening cycle. That might appear an easy way to calm markets. But as long as energy prices remain elevated and concerns about second-round inflation effects persist, there is a limit to how far the ECB would be willing to go solely in response to wider sovereign spreads.
A more targeted option would be to suspend quantitative tightening by resuming reinvestments. The ECB could even frame such a move as part of a broader adjustment of its balance-sheet policy, particularly as excess liquidity in the banking system approaches levels at which demand for central bank refinancing is expected to become more important. In theory, liquidity operations should take over at that stage.
But as long as borrowing from the ECB continues to carry some stigma for banks, ending QT and resuming reinvestments could address two issues at once: easing pressure on sovereign bond markets while also slowing the decline in excess liquidity. If turmoil were to spread further beyond France and threaten the transmission of monetary policy, the ECB could ultimately deploy its Transmission Protection Instrument. TPI comes with eligibility considerations, including compliance with the EU fiscal framework and debt sustainability, both of which would clearly matter in the case of France, although the ECB retains a degree of discretion in its assessment.
We think the bar for the ECB to actively intervene is high, however. By comparison, when the ECB intervened directly in Italian government bonds under the Securities Markets Programme in 2011, 10-year BTP-Bund spreads had moved beyond 500bp. French bond spreads are already wider than fundamentals alone would imply Source: Refinitiv, rating agencies, ING "> Source: Refinitiv, rating agencies, ING Germany hides in a temporary safe haven from the “Bad” Germany sits at the opposite end of the spread spectrum from France.
Bunds have reasserted their traditional role as a safe haven during the turmoil in French government bonds. During the geopolitical tensions at the start of the Iran conflict, evidence of such safe-haven demand had been fleeting. This time, the richness of Bunds looks more persistent because the turmoil goes to the heart of some of the monetary union’s longstanding vulnerabilities.
Yet the structural forces that had previously driven the cheapening of German government bonds have not disappeared. Bond supply is likely to increase again as the government continues to roll out its investment and defence spending agenda. The German Finance Agency’s funding head has indicated that gross bond funding could exceed €400bn next year, around €50bn more than this year and making Germany the largest issuer of the union.
Higher redemptions mean that the increase in net issuance is likely to be only around half as large. But the market must also absorb the German government bonds running off the ECB’s balance sheet. We estimate that this could add at least another €80bn to the amount the private sector needs to absorb over the coming year.
At the same time, political instability threatens the government’s reform agenda precisely when Germany needs to reset its economic model. An already fragile governing coalition will face five state elections, four of them concentrated in April and May and the other in September. Once the immediate flight-to-quality premium fades, we expect 10-year Bunds to cheapen back to at least 20bp over OIS, from around 13bp currently.
Domestic fiscal and political factors could push the spread wider still by the end of the year. 10y Bund safe haven dynamics outweigh structural issues for now Source: Refinitiv, ING "> Source: Refinitiv, ING 2027, likely a showdown in two parts The first half of next year will still be dominated by eurozone political risk. France’s 2027 budget might offer temporary but welcome relief at the start of the year, when an important funding window traditionally opens for many issuers beyond the government bond market. The second half of the year may offer relief from the turmoil, largely contingent on the outcome of the French elections and whether a new president can offer a credible path towards fiscal consolidation.
But at that point, Germany, as a core issuer, becomes exposed again to its domestic structural cheapening factors. Rates strategy Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument.
Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Author Benjamin Schroeder Senior Rates Strategist Benjamin Schroeder is a senior rates strategist at ING in Amsterdam. Before joining ING in 2016, he worked in fixed income research at Dresdner Kleinwort and Commerzbank in Frankfurt, Germany.… In this article European government bond markets – in a duel with the “Bad” France – Facing the very “Bad”, the one that could change it all The ECB can cap spreads, but does it want to? Germany hides in a temporary safe haven from the “Bad” 2027, likely a showdown in two parts