French fiscal woes spill over to euro

Yesterday's EUR/USD drop below 1.1200 could be mistaken for simply a stronger dollar. But the euro's slide to a 17-month low near 1.1160 also reflects developments closer to Europe.

In short, France's budget problems are increasingly becoming a problem for the euro itself.

The concern is straightforward. For years, France has struggled to convince investors it can meaningfully reduce its deficit, especially given a divided political backdrop that makes fiscal tightening tough. That uncertainty has been most visible in bond markets.

Investors now demand a larger premium to hold French government bonds over safer German bunds, sending the French-German 10-year yield spread sharply wider. This is where the story extends beyond France.

EUR/USD fell sharply in early trading yesterday before partially recovering. The decline briefly took the pair to its lowest since May 2025.

One might wonder why French budget issues affect the euro.

Markets are no longer only questioning whether France can fix its finances. They are also asking if rising French borrowing costs could spill over into other euro area countries.

If that happens, it would no longer be just a French risk but a euro area fragmentation risk.

Consider it a chain reaction. French fiscal worries first push French bond yields up. Wider spreads then raise questions about pressure spreading to Italy or Belgium. That makes European assets less attractive and gives investors a fundamental reason to cut euro exposure.

There is also the ECB angle to consider.

If higher borrowing costs tighten financial conditions and hurt growth, the ECB may have less room to raise rates. That becomes especially relevant when US Treasury yields remain high, supporting the dollar. This creates a double whammy: pressure on the euro from within, while higher US yields boost the dollar.

It would be wrong to say France alone caused yesterday's euro selloff. Dollar strength and elevated Treasury yields also played a role. But with the euro at a 17-month low, French fiscal risk can no longer be seen as isolated to bond markets. If French spreads keep widening, the euro will be a clear place where that stress appears.