MUFG goes short EUR/JPY, targeting 172 amid French bond turmoil and BoJ tightening

Two opposing forces are aligning according to the call: euro-area front-end yields are slipping as markets scale back expectations for ECB rate increases, while the yen is drawing support from anticipated Bank of Japan tightening and safe-haven flows. The pair remains vulnerable to further risk-off moves, since climbing volatility tends to speed up unwinding of carry trades that use the yen as the funding currency. A fresh widening in French bond spreads would likely act as the catalyst for the next downward move. On the flip side, any indication that forced selling of French OATs is running out of steam, or that the French budget secures smooth passage, could trigger a sharp short-covering bounce in the euro. The Iran war's energy price shock adds to Japan's import expenses, which could curb the yen's gains if oil spikes again.

Earlier:

• French stock market says 'au revoir'

MUFG believes France's bond market stresses will dampen the ECB's inclination for rate hikes just as the BoJ grows more open to them, a setup that gives EUR/JPY room to decline.

Summary:

• MUFG recommends a new short EUR/JPY: entry at 177.50, target 172.00, stop-loss 181.50.
• The pair has regained downward momentum after breaking back below 180.00.
• A widening French-German bond spread is tightening euro-area financial conditions, reducing the need for aggressive ECB hikes. Hike pricing to mid-2027 is down around 30 basis points from its peak.
• MUFG expects another BoJ rate hike before year-end, narrowing yield gaps. The yen could also benefit from carry-trade unwinds if volatility rises.
• The main risk is a stabilisation in European bonds, as MUFG sees the French selling as forced and overdone.

MUFG has put forward a new short EUR/JPY trade, entering at 177.50 with a target of 172.00 and a stop-loss at 181.50. The bank contends that euro-area fragmentation risks and a hawkish stance from the Bank of Japan point to additional downside for the currency pair.

The bank observed that the pair has recovered its downward momentum after dropping back below 180.00 in recent weeks.

On the euro side, MUFG noted that the spread between French and German bond yields has widened more sharply than anticipated, leaving the single currency exposed. Spreads have also increased in Spain, Greece and Portugal. The resultant tightening of financial conditions reduces the urgency for the European Central Bank to raise rates as aggressively as the market expects. ECB President Christine Lagarde said on September 28 that higher long-term yields would slow growth and reduce inflation pass-through by more than projected. Pricing for ECB hikes by mid-2027 has since fallen around 30 basis points from its peak. MUFG expects more such pushback if the bond sell-off resumes, which would likely weigh further on the euro. Options flows have also turned among the most euro-negative in recent periods, suggesting markets are pricing a lasting French political risk premium.

For the yen, MUFG expects the Bank of Japan to deliver another rate hike before year-end, though probably not this month, narrowing yield differentials with the euro area. The yen could also gain if market volatility rises further and triggers an unwinding of yen-funded carry trades. The yen and Swiss franc were the best-performing G10 currencies in the week to October 2 as risk aversion intensified.

The main risk to the trade is a stabilisation in European bond markets. MUFG views much of the French bond selling as forced and overdone, and said a calmer backdrop could prompt a reversal. A move above 181.50 would invalidate the idea.