Euro‑Skeptics, Politics, and a Wild Card of Spread‑Drama
It’s become clear that the euro’s biggest headaches aren’t just about inflation or the ECB’s next rate cut. It’s a mix of politics, politics, plus a sprinkle of market panic over widening spreads. Yesterday’s market chatter stopped short of mentioning the “tip of the iceberg” that these worries represent—if that’s even the right phrase.
Spreads: Not Just “Core vs. Periphery” Anymore
Traditionally, traders worried about the gap between core and periphery bonds. Now the story is a bit different: we’re looking at widened core‑vs‑core spreads. That means the 10‑year difference between French OATs and German Bunds has exploded to >80 bp—its widest since 2012. For comparison, last week alone saw the gap drift up almost 30 bp, nothing short of a record one‑week jump.
But France isn’t the only country feeling the heat.
- French‑German spread: widest since February
- Spanish‑German spread: also expanding rapidly
- Greek‑German spread: hitting extension since late‑2023
These figures mean a full‑blown fragmentation risk—higher yields press against borrowing across the bloc, hitting the debt‑heavy periphery days in the hardest.
ECB’s “Dovish” Posture vs. Political Turmoil
What makes this more unsettling for policy makers is that spreads are widening despite the ECB keeping a relatively dovish stance. In June, the Governing Council still trimmed rates by 25 bp—what they had already promised—despite a hotter-than‑expected May HICP and upward revisions to 2024/25 inflation forecasts. Since the June decision, commentary has stayed amenably dovish, with the next 25 bp cut feeling almost inevitable post‑Summer break.
Now, the plunge is not due to monetary policy but politics. The European Parliament election showed a rightward surge, populist parties bumping up support: France’s National Rally, Italy’s Brothers of Italy, Germany’s AfD, and others. France has felt the heaviest recoil—Le Pen’s RN party spiked, prompting President Macron to announce snap legislative elections for 30 June & 7 July.
Markets barely rhyme with politics: they’re notoriously bad at pricing in sudden shifts. So, when political ripples hit France, both fixed‑income and equities took a tumble.
What Does This Mean for the Euro?
In a time of heightened uncertainty, the Euro faces a downward tilt until we get a clearer picture of the next French parliament. The bar for the ECB to step in and close spreads—using TPI—has been raised (befitting Lamarde’s 4‑year blunder). Chief Economist Lane said the recent market moves were not “disorderly” but just a repricing.
In short, even after the short‑term political dust settles, the euro may remain in the “short” camp. Fiscal misstep remains a big threat, especially if populist parties gain further seats.
- Both France and Italy are already on the verge of the EU Commission’s “Excess Deficit Procedure.”
- Budget deficits are a worrying issue—more support for populists would only worsen the situation.
So, if you’re looking for a bearish stance on the Euro, consider taking an angle on the GBP or the CHF—both might offer a calmer storm in the market’s blizzard.
