US Dollar recovery and France's debt concerns push Euro lower

• EUR/USD gives up earlier gains as the US Dollar recovers from three-week lows.
• The Euro remains under pressure from France's fiscal worries and widening bond yield spreads.
• The Euro faces further pressure from weak Eurozone Consumer Confidence ahead of the Fed and ECB policy decisions.

EUR/USD is down 0.33% on Thursday, with earlier gains erased by a recovery in the US Dollar (USD) from a three-week low reached during Asian trading hours. The Euro (EUR) also remains under pressure from political unrest in France and doubts over the country's fiscal outlook. Having pulled back from an intraday peak of 1.1256, the pair is trading near 1.1195 at the time of writing.

Investors are moving away from French government bonds amid street protests and lingering doubts about France's ability to restore its public finances. The selling has lifted the benchmark 10-year yield above 5% for the first time since 2002, while widening the gap over German government bond yields.

Bond markets are increasingly pricing in France's fiscal worries, according to strategists at Brown Brothers Harriman. They point to the “French 10-year bond yield premium over Germany … up over 100bps since late February to 175bps, closing in on its 2011 record high of around 190bps.” In their view, if “Italy’s 2018 budget crisis is any guide,” the spread “can widen to about 250bps and drag EUR/USD down to 1.1000.”

For the longer-term outlook, BBH says that “France’s 2027 presidential election could offer a similar turning point, but only if it produces a government able to deliver credible deficit reduction.” Pending such a change, the strategists warn that “French spreads remain vulnerable to further widening, keeping EUR/USD under pressure.”

The Euro came under additional strain after preliminary figures put Eurozone Consumer Confidence at -17.9 in October, a deterioration from -16.5 previously and weaker than the expected -17.

In the US, the Greenback is recovering despite a further retreat in US Treasury yields from multi-year highs. Demand for government bonds has strengthened as worries about AI-related investments put pressure on global equities. After touching 5.36% earlier this month, the benchmark 10-year US Treasury yield is trading near 5.06%.

Following an intraday low of 101.45, the US Dollar Index (DXY) is trading near 101.85. The index measures the Greenback against a basket of six major currencies.

Traders broadly anticipate unchanged interest rates from both the Federal Reserve (Fed) and the European Central Bank (ECB) at their October meetings. Nevertheless, further rate increases by year-end remain expected. Energy-related inflation risks stemming from Middle East tensions threaten to hold inflation above the respective 2% targets of both central banks.

Reports that the US and Israel are weighing fresh strikes against Iran after the US midterm elections have pushed oil prices to five-week highs. Continued Houthi attacks in Saudi Arabia are also increasing supply risks across the Gulf region.