Euro: Debt contagion fears weigh on EUR against US Dollar – Societe Generale

Societe Generale strategists note a fresh weakening of the Euro (EUR) as European spreads widen and US Dollar (USD) demand surges, pushing EUR/USD below 1.12, significantly lower than the European Central Bank's (ECB) 1.16 prediction for 2026-28. The depreciation of EUR complicates the inflation outlook, potentially sparking debate among the ECB regarding uneven policy transmission.

Speculative positioning now leans short Euro futures as fear of debt market contagion across Europe weighs on the currency. Rising yields and tightening XCCY spreads stem from this dollar demand, leading EUR/USD to dip below 1.12, its lowest since May 2025. This depreciation diverges from the technical assumption of 1.16 for the next few years, hinting at higher inflation and potentially eroding real disposable income for households due to elevated oil and natural gas prices.

With geopolitical tensions persisting, USD strength continues to pressure pairs like AUD/USD, which drops toward 0.6900 in late Asian trading, driven by US Dollar strength. Meanwhile, USD/JPY recovers from losses, trading near 158.00 in the Asian session, bolstered by geopolitical uncertainty and potential BoJ intervention. Gold sees a slight recovery but remains within previous ranges, while Bitcoin and Ethereum show mixed performance.

The ECB's dilemma is further complicated by the bond market already tightening, leaving the central bank with an increasingly challenging path to address inflation nearly double its target.