Euro rebounds as French-German bond spread narrows: what a yield spread is

The euro bounced back from its 17-month low on Tuesday after France took steps to reduce its budget deficit. The ECB reference rate for EUR/USD rose to 1.1269 on 6 October, up 0.58% from 1.1204 on 5 October, as the gap between French and German bond yields narrowed.

According to an investingLive European news wrap, EUR/USD rebounded as the French government acted on its deficit, "narrowing the OAT-Bund spread". FXStreet reports that a softer US dollar also helped, though concerns over France's fiscal position kept the euro's gains in check. The rebound is still small against the recent slide: the fixing stood at 1.1355 on 30 September. You can follow the pair on a EUR/USD chart, and our sister site has a market report on the euro's rebound from its 17-month low.

What is a bond yield spread?

A government bond is a loan to a government. The yield is the yearly return an investor earns for making that loan, shown as a percentage. A yield spread is simply the difference between two yields.

In Europe, traders watch the spread between French 10-year bonds (called OATs) and German 10-year bonds (called Bunds). Germany is seen as the safest borrower in the euro area. So the spread shows how much extra return investors demand to lend to France instead of Germany.

• A wider spread means investors are more worried about France.
• A narrower spread means those worries are easing.

Spreads are usually measured in basis points (bp). One basis point is 0.01 percentage point, so 100 basis points equal 1 percentage point.

Why does this move a currency? When investors fear a big euro-area country's debt, some sell euro assets, which weighs on the euro. When the fear eases, that pressure can fade.

A worked example

Step 1: the spread. investingLive reports that the French-German 10-year spread surged above 150 basis points last week, its widest level since the euro-area debt crisis.

• 150 bp ÷ 100 = 1.50 percentage points
• On a €100 bond, that is €100 × 1.50% = €1.50 more interest per year than Germany pays.
• On €1,000,000 of debt, it is €1,000,000 × 1.50% = €15,000 more per year.

That extra cost is the market's price for the risk it sees in France.

Step 2: the currency. As the spread narrowed, the euro recovered.

• 1.1269 − 1.1204 = 0.0065, or 65 pips
• 0.0065 ÷ 1.1204 = 0.0058, or about 0.58%

Remember these are ECB fixings, one per business day. FXStreet put the live pair around 1.1255 later on Tuesday, up 0.29% on the day.

Why it matters for new traders

Currencies do not move on central-bank news alone. Bond markets often send the first warning. TD Securities, cited by FXStreet, says recent EUR/USD weakness was driven by high oil and diesel prices and French OAT concerns. Investing.com reports that Treasuries and Bunds gained on safe-haven flows while French bonds were left on the sidelines.

Also keep in mind that one driver rarely works alone. On the US side, UOB's Alvin Liew, quoted by FXStreet, says weaker September payrolls have reduced expectations for an October Fed rate hike, with markets now focused on September CPI. A softer dollar and a calmer spread both pushed in the same direction on Tuesday. On another day they could pull in opposite directions.

A practical habit: when the euro moves sharply, check whether a bond spread moved too. It helps you tell a currency story from a debt story.

Key terms

• Yield: the yearly return on a bond, in percent.
• Yield spread: the difference between two bond yields.
• Basis point (bp): 0.01 percentage point; 100 bp = 1 point.
• OAT: a French government bond.
• Bund: a German government bond, seen as the euro area's safest.
• Fixing: the ECB's official daily reference rate, not a live quote.