Fiscal troubles for the euro may only be starting
The desk projects significant downside risks for the euro amid escalating fiscal troubles, particularly as France's recent budget announcement could exacerbate OAT underperformance. Per the full note, today's widening in eurozone spreads, notably reaching a 130bp difference between French and German 10-year bonds, signals that market stress is beginning to impact euro pricing, particularly in both EUR/USD and EUR/CHF. With a consensus target for EUR/USD around 1.1700, traders should remain cautious, given this backdrop of rising yield volatility and broader financial market tightening.
What the desk is arguing
The desk asserts that the euro faces notable downside risks stemming from fiscal concerns within the eurozone, particularly following France's latest budget announcement. Per the full note, ongoing fiscal pressures could lead to further widening of spreads, notably the risk premium embedded in OAT pricing, which remains unresolved amidst upcoming election uncertainties.
Current dynamics show EUR/USD staying resilient at 1.1446; however, analysts are warning of potential depreciation if fiscal measures are not adequately addressed. The French-German spread increase paralleled a 130bp high, indicating growing market anxiety that could soon translate into euro weakness.
Where it sits in our coverage
Our current consensus target for EUR/USD stands at 1.1700, with a range of 1.1200 to 1.2000 as seen in forecasts from various firms: - socgen: Dec26 target 1.1400 - barclays: Dec26 target 1.2100 - cibc: Dec26 target 1.2200
This outlook suggests a divergence from the desk's view, which anticipates potential downside movement that leans towards the lower bounds of consensus as concerns mount over fiscal stability.
How other firms see it
Firms like socgen and bofa share a more cautious outlook, signaling some-level alignment with our bearish perspective. In contrast, nomura and cibc maintain more optimistic targets for EUR/USD, indicating a belief that the euro will remain buoyant.
The overall trajectory of EUR/USD appears reflective of developments in eurozone fiscal policies, with significant attention warranted on the evolving bond market conditions, particularly the relationship with the ECB's monetary adjustments.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Escalating fiscal issues in the eurozone, particularly from France, pose serious downside risks for the euro.
- 02Recent widening of the French-German 10-year yield spread to 130bp indicates increased market stress.
- 03Consensus targets for EUR/USD are at 1.1700, but risks align more closely with bearish forecasts amid fiscal uncertainties.
Market implications
Traders should closely monitor the EUR/USD as it approaches critical support levels; a break below 1.1400 may accelerate selling pressure. Also, keep an eye on upcoming election developments in France, which could further impact fiscal outlooks and subsequent euro performance.
Risks to this view
A reversal in the desk's bearish outlook could occur if France implements credible fiscal reforms or if the ECB signals a stronger monetary response to inflationary pressures, reassuring investors and stabilizing spreads. Additionally, shifts in the market's risk appetite can quickly shift sentiment away from the dollar's safe-haven status.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
MUFG | Bullish | 1.1800 |
Danske Bank | Bearish | 1.1100 |
UBS | Bullish | 1.1800 |
Articles Fiscal troubles for the euro may only be starting Published 15:04 FX Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download History suggests that the euro’s correlation with eurozone spread widening can pick up rapidly. Today’s budget announcement in France leaves OATs at risk of further underperformance, and a so far resilient EUR/USD may be looking at material downside risks if things don’t improve. EUR/CHF is facing similar depreciation potential Francesco Pesole EUR/USD has remained resilient thus far after the announcement of the French budget, but there can still be material downside risks if there is no improvement FX spillover from France is starting This morning's market chatter is increasingly focused on widening eurozone spreads finally spilling over into the euro, with the French-German 10-year spread reaching 130bp.
Both EUR/USD and EUR/CHF have moved lower today. The latter is providing the clearest signal that bond market stress is feeding into FX. The dollar continues to benefit from broad-based support, driven by tighter global financial conditions, elevated energy prices and a hawkish Fed.
Instead, the Swiss franc’s momentum was bearish until this morning, with a dovish surprise last week by the Swiss National Bank weighing on the currency. Our colleagues analyse today’s budget announcement in France in this note . ING’s view is that this budget buys some time but fails to solve structural deficit issues.
Markets still have little incentive to price fiscal premia out of OATs, and with no party having presented a sufficiently detailed spending cut plan, the upcoming elections are adding to the uncertainty. Our rates team believes 150bp may be the next step for the 10yr OAT-Bund spread. That creates material downside risks for the euro.
Rising yield volatility and the prospect of wider spreads are pushing the market back into an environment where the euro becomes much more sensitive to the fiscal and bond narrative. We have seen similar episodes before, often centred on Italy. Yet the euro's response has so far been remarkably muted compared with those earlier periods.
In the chart below, we highlight (orange bars) episodes when the average 10-year spread of France, Spain and Italy versus Germany widened by at least four standard deviations relative to its six-month mean. The light blue line shows the deviation of EUR/USD from its short-term fair value, i.e. the risk premium on the euro. In most of the other instances of sharp spread-widening, the euro suffered from much more idiosyncratic pressure.
For now, that undervaluation is at a modest 1%. The euro's reaction has been contained compared to past episodes Source: ING, Refinitiv "> Source: ING, Refinitiv EUR downside risks increasing That is mostly bad news for EUR/USD, with a couple of caveats. The negative aspect is that there is still plenty of room to catch up with the fiscal story.
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