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The EUR/USD is experiencing support as US rates decrease, and French PM Sébastien Lecornu seems likely to withstand no-confidence votes in parliament. This development follows an agreement to delay pension reforms to appease the Socialists.
The euro and French bonds view these events positively in the short term. However, delaying pension reforms complicates long-term fiscal consolidation efforts. Bond market participants appear to favour this delay over the possibility of early elections, pulling OAT:Bund spreads back within 80bp.
Currency Pair Movement
FX traders might align with bond market reactions, implying positive movement for the euro. Despite this, breaking the EUR/USD above the 1.1685/1730 range soon seems unlikely. Prolonged consolidation could lead to gains as the currency pair approaches a typically bullish period in November and December, with a year-end estimate of 1.20.
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With US interest rate expectations softening, the EUR/USD is finding some footing. Recent data showing US headline CPI cooling to 2.8% has pushed the 10-year Treasury yield back below 4.0%, taking some pressure off the dollar. This provides a supportive backdrop for the euro as we head into the final quarter of the year.
The immediate political risk in France is fading, which is calming sovereign debt markets. The spread between French and German 10-year bonds has tightened back to 78 basis points, a signal that investors are less worried about instability for now. We see FX traders taking this as a green light, viewing the stable French bond market as a positive for the single currency in the short term.
Derivatives Trading Strategy
For derivatives traders, the current environment suggests a two-tiered approach. With the spot price consolidating below the significant 1.1730 resistance level, selling November-expiry call options with a strike price around 1.1800 could be a viable strategy to earn premium. This capitalizes on the view that a major breakout is unlikely in the immediate coming weeks.
Looking further out towards year-end, we maintain a more bullish outlook with a target of 1.20. The historical seasonal tendency for the US dollar to weaken in December, as we saw in late 2023, provides a tailwind for this view. Traders could consider buying December-expiry EUR/USD call spreads, such as buying the 1.17 call and selling the 1.20 call, to position for this potential move in a cost-defined manner.
