A prime spot never stays empty. If investors are losing confidence in France and Europe as a whole, why not move their capital into US markets? US bonds offer attractive yields while default risks remain relatively low. Let’s explore this shift in capital flows and develop a trading plan for the EUR/USD.
The article covers the following subjects:
Major Takeaways
- The cost of insurance against a French default is rising.
- The risk of a recession in the US economy is declining.
- The dollar is benefiting from capital inflows.
- Short positions can be opened with a target of 1.1000.
Weekly Fundamental Forecast for Dollar
Germany in September, followed by France and Spain in October. Fiscal pressures across the region are becoming harder to ignore, with persistent deficits and rising public debt raising investor concerns. In France, debt-servicing costs have risen above those of Greece and Italy, while the budget deficit remains larger than the US’. Public debt is also approaching 120% of GDP. At the same time, neither the political left nor the right appears willing to prioritize strict fiscal consolidation, adding to uncertainty over the eurozone’s fiscal outlook.
Credit-Default Swap Spreads
Source: Wall Street Journal.
Investors are now paying more than twice as much to insure against a potential French default as they did just a week ago. The cost of hedging against default risks in Italy and other peripheral European economies has also increased. Concerns are mounting over Paris’s plans to issue an additional €340 billion in bonds as it seeks to reduce the budget deficit to 5% of GDP. With 10-year bond yields at 5% or higher, the French Ministry of Finance expects debt-servicing costs to rise by 59% by 2030.
Why take on such risks when capital can be allocated elsewhere? In the United States, for example, the yield curve is gradually moving away from inversion, which may indicate that recession fears are easing.
US Yield Curve
Source: Wall Street Journal.
Markets currently price in a 24% probability of a federal funds rate hike in October, well below the 73% probability seen before the speech by John Williams, President of the Federal Reserve Bank of New York. This shift in expectations is contributing to a slower rise in 2-year Treasury yields compared with 10-year yields. Meanwhile, the probability of a rate hike this month has risen to 18%, partly due to higher price indices in the ISM Services PMI, which reached their highest levels since 2022. At the same time, the employment index returned to growth after two consecutive months of decline.
Investors continue to favor the US dollar, attracted by relatively high Treasury yields, a resilient economy, and the dollar’s safe-haven status amid elevated geopolitical risks. Futures markets are also pricing in a more aggressive Fed tightening cycle than those of other major central banks. The ECB faces constraints from political and fiscal risks, as well as concerns that the eurozone economy may struggle to withstand higher interest rates.
The euro is also under pressure from signs that sovereign debt concerns are spreading beyond France, as well as deteriorating terms of trade caused by the eurozone’s position as a net importer of energy commodities. For now, there appears to be little relief for the euro. Political uncertainty in Spain is adding to the pressure, further complicating the outlook for the EUR/USD pair.
Weekly Trading Plan for EUR/USD
Against this backdrop, it is still too early to conclude that the downtrend in the EUR/USD has ended. Any upward correction could present an opportunity to open short positions, with a potential downside target of 1.1000.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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