The euro was heading for a fourth consecutive weekly decline against the US dollar on Friday, putting the currency on course for its steepest weekly loss in about four months as concerns over France’s deteriorating fiscal position combined with a more hawkish US interest-rate outlook to weaken demand for the single currency.
The euro fell sharply on Thursday and was broadly stable on Friday as oil prices eased amid discussions over the release of diesel and crude inventories. It was down 0.05% at $1.1240 by 1127 GMT and was on track for a 1.35% decline for the week, its largest weekly fall since mid-May.
The retreat has reversed some of the euro’s earlier strength and illustrates how quickly currency markets can shift when interest-rate expectations, energy prices and sovereign-risk concerns move in the same direction.
Register for the next Tekedia Mini-MBA.
Register for Tekedia AI in Business Masterclass.
Join Tekedia Capital Syndicate and co-invest in great global startups.
The dollar index, which measures the US currency against six major peers, slipped 0.1% to 102.03 on Friday but remained on course for a 1.01% weekly gain, its third consecutive weekly increase.
Higher oil prices have also supported the dollar because investors typically reduce exposure to currencies of major energy importers such as the euro and yen when crude prices rise. Europe and Japan are particularly vulnerable to an energy shock because higher fuel costs can worsen trade balances while simultaneously pushing inflation higher.
France Becomes A Growing Source of Pressure For The Euro
The euro’s weakness is largely tied to concerns about Europe’s fiscal and political outlook, particularly in France. French government bonds have come under heavy selling pressure, pushing the 10-year yield to its highest level since 2002 on Thursday. The spread between French 10-year bonds and benchmark German Bunds, a widely watched measure of the additional risk investors demand to hold French debt, widened beyond 150 basis points on Friday.
That was the largest gap since the euro zone sovereign debt crisis in 2011, highlighting the extent to which concerns over France are being reflected in European bond markets.
The pressure has also begun spreading to other heavily indebted countries, including Italy and Greece, although both have made progress on their fiscal positions.
France’s budget and political uncertainty are weighing heavily on the euro because concerns over government finances can raise borrowing costs, tighten financial conditions and complicate the European Central Bank’s policy decisions.
“Layered on top of worries about low European gas storage, already high energy prices, persistent competition from China, a weakened chancellor in Germany and the risk of hybrid attacks from Russia, the outlook for the euro is clearly on a weakened footing relative to last year,” said Jane Foley, senior forex strategist at Rabobank.
She also pointed to France’s budget and political backdrop as factors weighing on the currency.
The energy question is adding another layer of uncertainty. European Union countries discussed a French proposal on Friday to release diesel reserves following pressure from the United States to help cool surging fuel prices. At the same time, euro zone inflation is expected to rise in the coming months, potentially complicating the ECB’s policy path. Higher energy costs can feed directly into consumer prices while also weakening household purchasing power and economic activity.
That combination puts policymakers in a difficult position: inflation may require tighter monetary conditions even as fiscal concerns and higher borrowing costs place additional pressure on governments and the broader economy.
UBS has taken a more constructive view of the currency at current levels, arguing that France’s fiscal difficulties are unlikely to produce an immediate funding crisis. The bank said a credible fiscal consolidation plan could restore investor confidence and viewed current prices as an opportunity to gradually increase euro exposure.
The contrasting views underpin the uncertainty surrounding the currency. The deterioration in French bond markets has been substantial, but it has not yet established that France faces an imminent sovereign funding crisis.
Fed Expectations Shift As Markets Await US Jobs Data
The euro’s decline has also been reinforced by changing expectations around US monetary policy.
The Federal Reserve raised rates and signaled the possibility of further increases in mid-September, strengthening the dollar by increasing the relative return available on US assets. Fed Chair Kevin Warsh has also reaffirmed the central bank’s independence amid repeated calls from US President Donald Trump for lower borrowing costs.
That policy divergence has made the interest-rate gap between the United States and Europe an important driver of the euro-dollar exchange rate.
However, expectations have shifted again this week after softer US inflation data. Consumer prices rose less than expected in August, while July’s inflation figure was revised lower, prompting traders to reduce bets on another Federal Reserve rate increase later this month.
Two senior Fed policymakers also argued during the week for gathering more economic data before deciding on another move, adding to uncertainty ahead of the latest employment report.
Markets were pricing a 72% probability of the Fed leaving rates unchanged in October, up sharply from 36% a week earlier, according to CME FedWatch.
The US payrolls report therefore became the immediate focus for currency traders. Economists expected job growth to slow in September, while the unemployment rate was forecast to remain at 4.1% for a third consecutive month.
A weaker employment report could reinforce expectations that the Federal Reserve will hold rates steady, potentially limiting the dollar’s recent gains. Stronger labor-market data, however, could revive expectations for tighter policy and provide another source of support for the US currency.
The problem for the euro is that several risks are arriving simultaneously. France’s fiscal position is increasing the premium investors demand to hold its debt, energy costs remain a threat to European inflation, and the region continues to contend with weak competitiveness concerns and geopolitical risks.
The euro’s fourth straight weekly decline therefore represents more than a simple shift in exchange-rate momentum. It shows how fiscal risk in a major euro-zone economy can feed into sovereign bonds and then into the currency, particularly when the US dollar is simultaneously benefiting from relatively higher interest rates and stronger investor demand.
The immediate direction will depend heavily on US employment data and the resulting adjustment in Federal Reserve expectations. Beyond that, however, the euro’s recovery is expected to hinge on France’s ability to restore confidence in its public finances without aggravating the political tensions already weighing on European markets.