Daily Brief – It couldn’t last forever

It couldn’t last forever

Throughout late August and into September, an unsettling sense of content with the state of the European economy had established itself. We noted at the time that a similar rose-tinted view of the Eurozone economy had emerged several times over the last few years, often driven by a period of not-so terrible data and news flow. We cautioned that, as in previous episodes, it was unlikely to last forever or even five minutes, and today it seems that call has been met.

Despite economic data continuing to be favourable in the Eurozone, and the ECB now on a very different trajectory than was seen earlier in the year, sentiment is still appearing to sour surrounding the Eurozone. EURUSD has managed to erase all of its September gains as the Dollar also begins to gather buying interest. To validate this move, the options market has also now shifted to price downside exposure on the Euro at a higher price (by 20 vols) versus upside exposure.

The catalyst for the turning of the tide on Euro sentiment is undoubtedly politics. Much of that political upset is attributable to Germany and the two consecutive state-level defeats of the CDU. The comparable outperformance of the AfD is disturbing markets and causing the yield on German bunds to move higher. Perhaps of even greater concern is the fact that the spread of other national debts over Germany is reaching significant and stretched levels. Take France, for example, whose only real upcoming political risk event is next year in the 2027 presidential elections: the spread of French debt over German, the OAT-Bund spread, now stands in excess of 100-basis points. That’s a one-year high and, for context, significantly higher than the 90-basis points reached in 2024 when snap elections shocked the market.

Discussion and Analysis by Charles Porter

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