Euro drops to 17-month low of $1.1161 as French debt sell-off widens bond spread to 152 basis points

Currency and debt sell-off

The euro fell 0.8% in Asian trading on Monday to 1.1161 dollars, marking its lowest level against the US dollar since May 2025. The decline deepened as hedge funds sold the single currency for dollars on spot markets, triggering stop-loss option barriers. The currency has lost 4.8% against the dollar since the start of 2026 and more than 1.6% since the previous week. Selling pressure also expanded to French government debt, where 10-year bond yields climbed to 4.9%, an increase of 1.2 percentage points since the end of June. The yield spread between French 10-year bonds and German Bunds reached 152 basis points on Friday, the widest premium recorded since 2011.

The politics of Europe are really starting to deteriorate.

Japanese capital flight and fiscal concerns

Japanese institutional investors held approximately 23 trillion yen (close to 145 billion dollars) in French debt in July, accounting for 6.6% of their foreign fixed-income assets. This exposure represented the largest euro-area sovereign overweight among Japanese funds relative to benchmark global indices. Sumitomo Mitsui DS Asset Management sold all its French government bond holdings, shifting capital into German Bunds and short-term Japanese government debt. Rising yields on domestic Japanese debt have encouraged capital repatriation, reducing the incentive to hold foreign sovereign paper. Currency-hedged French 10-year bonds offered a yield advantage of roughly 40 basis points over Japanese government debt, a margin strategists considered insufficient to halt the outflow.

French bonds offered relatively attractive carry options, but due to recent developments we sold our entire position.

Political gridlock in Paris and Madrid

Market anxiety mounted over budget deficits and political instability in the euro area. The French government presented proposals to reduce its fiscal deficit through spending reductions and higher tax revenues, prompting legislative pushback that threatens the cabinet. France had targeted a budget deficit reduction to 5% of gross domestic product this year, but fiscal balances moved in the opposite direction. A poll released last week showed National Rally leader Marine Le Pen and left-wing politician Jean-Luc Mélenchon qualifying for the second round of the 2027 presidential election. In Spain, members of Prime Minister Pedro Sánchez's Socialist administration considered calling snap elections after parliament rejected a flagship housing bill last week.

Bond and currency markets clearly signal investor unease over increasing instability in the French government and the erosion of the country's fiscal anchor ahead of the 2027 election.

Central bank divergence and dollar strength

The euro encountered additional headwinds from a strengthening US dollar and monetary policy expectations. The Bloomberg Dollar Spot Index rose on Monday to its highest level since late June, supported by market expectations that the Federal Reserve will implement three rate increases by July to control inflation. Strategists at JPMorgan noted that foreign exchange markets had not yet fully absorbed the widening in French bond spreads, making the euro vulnerable to further losses against the Swiss franc and Japanese yen. The euro declined 0.5% against the Swiss franc on Monday, recording its third consecutive daily loss.