Is French politics about to give the euro a nasty reality check?

The Jackson Hole storm in a teacup
Friday’s Jackson Hole speech by Fed Chair Powell sparked an intense reaction in the US dollar as Powell waxed more dovish than anticipated, more clearly setting up a Fed rate cut in September than was anticipated before the speech, but the US dollar looked exaggerated relative to the move in US interest rates. Clearly, incoming data is in the driver’s seat as we are long past the era of forward guidance and the focus is more intently on how countries will grapple with stagflationary dynamics and the pressure on interest rates and keeping orderly sovereign bond markets in debt-saturated economies.

Eurozone foundational questions coming back to haunt the euro?
EURUSD remarkably hit 1.1740+ on Friday before plunging back to nearly 1.1600 yesterday as the market has decided that French politics are worth consideration, as well as perhaps the perennial risks that “original foundational sin” of the Eurozone are set to come back to haunt it: multiple sovereigns and a single central bank. Specifically, French PM Bayrou is calling a confidence vote on September 8 to see if the parliament will agree that a significant austerity plan is needed to rein in large French deficits that are still nearly twice the 3% allowed under EU rules.

The ballooning France-German 10-year yield spread – now at 77 basis points versus 65 basis points a couple of weeks ago, suggest that the market is concerned that the government will fail. Watch France-Germany spreads closely from here after the cycle high the last time around before Bayrou became PM widened to as high as 88 basis points. Can the bond vigilantes corral the French politicians into moving forward with austerity or are they willing to test the “Truss-nomics” risks to French debt should they allow the government to fail? After the brutal austerity of the post Eurozone debt crisis years from 2010, it is hard to believe that any of the periphery will feel the slightest sympathy for France’s plight and what  scale of emergency in French debt would it take for the ECB to intervene? EURUSD aside, looking in the Euro crosses, from EURNOK and EURSEK to EURNZD and EURAUD, the single currency looks absurdly elevated if we are set for a test of France’s bond market.

President Trump trying to fire Fed Governor Lisa Cook
President Trump says he is firing Fed Governor Lisa Cook, effectively immediately. In theory, Trump can only fire a Fed Chair or Fed Governor “for cause”, i.e., due to serious misconduct or neglect of duty. In this case, Trump’s team is seizing on supposed improprieties linked to Cook’s mortgage application in order to obtain better terms on her mortgage. Cook says that she won’t go. I am no expert on the judicial process here, but according to an AI inquiry (ChatGPT), this could go through as many as two layers of federal courts before possibly going to the Supreme Court if the standoff continues. The stakes are high here as the removal of Cook would give Trump a majority on the Fed, even before nominating a new Fed Chair to replace Powell.

How this works for or against the US dollar is complicated, when we have most of the major currencies involved in similar dynamics: the risks of a sovereign debt crisis that demands a policy response when strains start so show. Whether it is the UK, Japan, US or France, the deficit and/or debt trajectory sustainability questions are the same, with varying degrees of wherewithal and nimbleness to address the issue if a crisis should break out. France has the most cumbersome situation as it has no central bank and has to rely on the ECB for stabilization in an emergency. So, while the political theater in the US is the most distracting, in part on Trump’s style, the US is not an outlier in terms of the shape things will take from here as central banks lose independence in the next rounds of policy responses.

Chart: EURUSD
EURUSD has been choppy, to say the least, over the last couple of days, first pumped higher on the dovish Jackson Hole speech from Fed Chair Powell before the import of that speech was second guessed. Then, adding to the risks for the euro are the fresh turmoil in French politics and showdown into early September over proposals to impose an austere budget that doesn’t look like it will fly with the leftists or the populist right. Meanwhile, US Fed independence is clearly on the way out, whether sooner on a Cook exit and dovish replacement, or later after Powell is replaced next May. Tactically, the hard reversal looks bearish, but we would need some follow through lower here below the recent 1.1583 low to set up a test of the next range lows below 1.1400 and possibly beyond to the downside.