This period of extended uncertainty risks hurting French assets and the single currency

Markets

The euro is in dire straits as the clock ticks down to tonight’s deadline for French caretaking PM Lecornu to report to President Macron on a potential roadmap to install a government. Monday’s semi-optimism about a possible muddling-through scenario makes way for the harsh reality that the current political set-up reached a dead end. Socialists and Republicans have ruled out any accord that would unite them in government, the extreme-right RN smells electoral success and opposes any leftist set-up and even Macron’s close ally Edouard Philippe suggested that Macron should horse-trade his presidency via snap presidential elections (normally 2027) in exchange for a caretaker government pushing through next year’s budget. Macron himself said on Monday that he would take responsibility if Lecornu offers no way out of the political mess. We consider this as calling snap legislative elections, with the two voting rounds to take place in the first half of November (20-40 days after calling elections). This period of extended uncertainty risks hurting French assets and the single currency. The French 10-yr OAT/swap spread tested the YtD top just below 90 bps for a second session straight. The single currency tested, and this morning lost, support coming from the downside of an upward trend channel in the 1.1645-area. The pair changes hands at 1.1615 and is at risk of rapidly sliding towards the early August low at 1.1392. Especially as the USD-side of the equation doesn’t play any role of significance with the government shutdown delaying key data releases and money markets happy with the prospects of 25 bps Fed rate cuts in October and December. FOMC Minutes of the September meeting will be published tonight but they will represent the wide range of view as spelled out in the Summary of Economic Projections and as seen in speeches by Fed governors since that meeting. The US Treasury continues its mid-month refinancing operation with a closely-watched $39bn 10-yr Note auction followed by a 30-yr bond sale tomorrow. The French political/budgetary crisis brings back public finances on bond markets’ radar as a market theme. The euro loses against sterling as well with EUR/GBP (0.8676) drifting from the upper end of the sideways trend channel in place since the start of July (0.8750) towards the lower bound (0.86). A speech by Bank of England chief economist Pill is worth watching today with the outcome of the November BoE-meeting potentially a closer call than markets currently discount (<10% probability of a rate cut).

News and views

The Reserve Bank of New Zealand cut its policy rate by a bold 50 bps. The decision at least surprised part of the market as a majority of analysts expected a more modest 25 bps step. The RBNZ assesses that annual consumer price inflation is currently around the top of the Monetary Policy Committee’s 1% to 3% target band. However, with spare capacity in the economy, inflation is expected to return to around the 2% mid-point over the first half of 2026. Economic activity through the middle of 2025 was weak, in part, due to domestic constraints on the supply of goods and services in some industries, and the impact of global economic policy uncertainty. Household consumption is recovering, partly because of lower interest rates, and elevated commodity prices continue to support the primary sector. Even as RBNZ both sees upside and downside risks to inflation it concluded that prolonged spare capacity and the associated downside risk to medium-term activity and inflation prevailed as a justification of a 50 bps step. The Committee even indicated that it remains open to further reductions as required. The 2-y NZ government bond yield declines 7 bps this morning (to 2.64%). The kiwi dollar lost about 1% and at USD/NZD 0.574 is trading at the weakest level since April.

Rating agency Fitch in a first assessment of after this week’s Czech elections, indicated yesterday that strong institutional checks will limit the scope for radical near term policy shifts by the next Czech government. It therefore expects the incoming administration led by the ANO-party to maintain a broadly prudent fiscal policy. At the same time, Andrej Babis, the leader of the ANO-party, yesterday indicated that the next government might need to increase the budget deficit for next year by CZK 60bn to provide funding for new spending priorities, including investment infrastructure. This additional deficit spending compares to a 2026 budget deficit proposal/draft of the current government of CZK 286bn, which was already higher than this year’s level due to higher defense spending.

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