Franco-German yield spreads suggest short-term fair value for EUR/USD is just below 1.05 and signs of contagion in the bond market mean that risks for the currency are tilted to the downside, according to Credit Agricole strategists.
If traditional spreads between peripheral European bonds and their German counterparts are substituted for the spread between French, or OATS, and German bonds in Credit Agricole's model, fair value for EUR/USD then falls to 1.0490 from 1.0687, the bank's strategists wrote in a note to clients on Monday.
"Our results suggest that EUR/USD is more closely following the price action in peripheral European Government Bond markets than the OAT market in isolation. That said, there are several reasons to expect that the risks for the FX pair and its fair value could be to the downside from here," they added.
French government bonds have fallen heavily with weakness spreading to other markets in Europe since President Emmanuel Macron called a snap election for June 30 and July 7 last week, while euro area stock indexes have also taken a hit and further undermined the appeal of the euro, according to Credit Agricole strategists.
The widening bond and equity sell-off risks undermining the eurozone economic outlook and could lead European Central Bank policymakers to adopt a more dovish stance on interest rates, which would add further weight around the ankles of the single currency, the Credit Agricole team argues.
EUR/USD was quoted 0.16% higher around 1.0710 in early North American trade on Monday.
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