Synopsis:
ING sees fiscal risks emerging for the euro, with rising defense spending needs in Europe potentially pressuring national budgets, particularly Italy's high debt-to-GDP ratio (~140%). This could reverse recent tightening in Italian-German bond spreads, adding a fiscal risk premium to the euro. In FX markets, EUR/USD faces downside risk, with a stall at 1.0450-1.0470 and potential drop to 1.0350 if Italian debt concerns escalate.
Key Points:
1️⃣ Fiscal Risk Premium Emerging for EUR
- US isolationism may force Europe to ramp up defense spending, raising concerns about who will finance it.
- Failure to secure EU-wide funding could increase pressure on local/national budgets.
- Italy is a key concern, with high debt (~140% of GDP) and rising defense spending needs.
2️⃣ Bearish Steepening in European Bond Curves
- German 2-10Y Bund curve steepened to 38bps—highest since Oct 2022.
- Increased government bond supply could pressure peripheral spreads, adding to EUR downside risks.
3️⃣ EUR/USD Target: 1.0350 Possible if Italian Bonds Weaken
- Limited US trade risk premium priced in EUR/USD for now.
- US consumer remains resilient; Fed is not rushing to cut rates, keeping USD supported.
- EUR/USD likely to stall at 1.0470; downside risk to 1.0350 if Italian bonds come under pressure.
Conclusion:
The euro faces new fiscal risk premium pressures, especially as Europe considers how to fund increased defense spending. If Italian debt concerns resurface, EUR/USD could decline to 1.0350 in the near term.
