European bond market calms, as focus shifts to FX

Key takeaways

• EUR drops to a 17-month low and trades below 1.12 USD.
• French and German 10-year yield spread widens due to political gridlock in France.
• Schneider Electric shares sink 10% after a 23.7 bn USD acquisition announcement.
• Brazil’s Bovespa index rallies as Flavio Bolsonaro wins the presidential primary round.

It’s all about FX on Monday. After bonds and stocks hogged the limelight this year, it is finally the currency market’s time to shine. The euro is in focus, as it drops to a 17-month low, as other markets struggle for direction as we move into the first full trading week of Q4. Parts of the European bond market remain a concern for investors, especially as political and fiscal gridlock in France pushes up the French- German 10-year yield spread, which is a key signal of financial stress. Spain is also in focus after news broke that there would be a snap election at the end of November.

However, French and Spanish yields are falling today, and bond prices are rising, especially at the short end of the curve. This may sound counterintuitive, but it is worth noting that European yields, especially French yields, have surged in recent weeks, so the pullback may only be temporary. French stocks have been hit hard on Monday, and the Cac is the weakest of the major global stock indices. It is down 1.2%, however, it has been led lower by Schneider Electric and news that it was buying a Boston-based industrial software group for $23.7bn, which did not go down well with the market. The stock price sank 10% on Monday, but this is not down to fiscal issues in France, and more to do with idiosyncratic factors at Schneider Electric.

French banks are also under pressure on Monday, which is a sign that rising bond yields could feed into stock market weakness down the line, since banks are a major component of European indices. However, so far the Eurostoxx 600 index is holding up and is higher by 0.1% so far today. It is remarkable how calm stocks have been in the face of the recent bond market distress, and we will watch to see if this continues. Politics is playing out in the stock market, and Brazil’s Bovespa is the best performing index today, after right-wing candidate Flavio Bolsonaro won the first round of the election, defeating left wing candidate Lula da Silva. The next vote is on 25th October, and polls suggest that Bolsonaro could secure victory.

Markets are in relief rally mode, as Bolsonaro is seen as being the more pro-business candidate and more fiscally conservative than Lula. The euro continues to hover below $1.12 vs. the USD on Monday afternoon, after losing 0.5% at the open. Although the currency remains vulnerable to a pullback towards $1.10, the market is wary of pushing it lower in the short term. EUR/USD is down 1.5% in the past week, and more than 3% in the past month. This is a big move by FX standards, and in the short term EUR/USD’s decline is on pause as we wait to see if Eurozone bonds will continue to sell off later this week. The drop in the oil price is helping to ameliorate the European bond market on Monday, and Brent crude continues to trade around $101.70 per barrel. Overall, markets are in wait and see mode, after panic set in about France’s fiscal woes last week. However, a deeper decline in the price of oil will be needed to keep the peace.

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