File image of Francois Bayrou. Image: Jacques Paquier, licensed as CC BY 2.0.
A new risk has pinged on the Euro's radar in the form of dysfunction in French politics.
Europe's national politics don't usually feature on the Euro's radar, but France is catching the market's attention again as its government could be set to fail.
Less than a year after Michel Barnier's government collapsed, the National Assembly is again asked to pass a confidence vote, this time on the government of Francois Bayrou, which wants to pass a plan to consolidate France's debt by £44BN via spending cuts and tax rises.
"In the next 13 days, the French people will choose, will influence their representatives to choose and say whether they stand on the side of chaos or on the side of consciousness and responsibility," Bayrou said, seeking to place pressure on resistant politicians.
The main opposition parties - National Rally, France Unbowed and the Socialists - say they will vote against a confidence motion over the matter, which would force the government to resign.
Rising political uncertainty was evident in a notable underperformance in French stocks on Tuesday, while the difference between the interest rates paid by French and German 10-year debt, which tells us how much premium investors are demanding to hold French debt, widened.
The vote is due on September 08, and building uncertainty on the outcome opens a window for the Pound and Dollar to rise against the Euro.
Analysis from ING finds the euro's correlation with the French-German bond spread tends to be either very low most of the time or quite high for short bursts, meaning that when French-related risks hit, they hit suddenly.
ING finds that for Italian bonds, the pain threshold on the spread was around 200bp, but for French bonds, there is no real historical precedent.
"We don't have enough history to be sure, but a break above December's high of 90bp (currently 77bp) can trigger a significant euro reaction," says Francesco Pesole, FX Strategist at ING. It was in December when Michel Barnier's government was toppled by the National Assembly, the first time lawmakers had collapsed a government since 1962.
For now, French politics appears to be treated with caution by the currency market, explains Pesole. Although the euro is not actively trading on the French political turmoil, "it's likely facing some degree of restraint from it."
Such restraint would be evident in a Euro-Dollar exchange rate that is capped below the 1.17 level and is effectively denied the chance to rally to year-end investment bank targets that are closer to 1.20.
It is also be evident in a Pound to Euro exchange rate that finds itself better supported with the potential to move back above 1.16 after a difficult few months.
If the pain threshold in bond markets identified by ING is crossed, then some meaningful declines in EUR/USD and EUR/GBP can evolve.
A failure of the current government would mean French President Emmanuel Macron would have to name a new prime minister who would attempt to unify a deeply divided legislature. He could reappoint Bayrou, or dissolve the assembly altogether.
Prediction markets accordingly assign more than an 80% chance that PM Bayrou leaves office by the end of September.
France is battling to bring its budget deficit down in order to shore up its financial stability and meet EU rules that mean countries cannot run massive deficits for fear of destabilising the monetary union.
Bayrou's government wants to bring the deficit down from 5.4% of GDP this year to 4.6% next year via spending cuts and tax rises.
If President Macron appoints a new government under the current Parliament, political parties could still have time to pass a budget before year-end.
"But the starting budget proposal would probably be less ambitious and still require concessions during parliamentary debates. In that case, we would look for a deficit of 5.2% of GDP next year," says a note on the matter from Goldman Sachs.