EUR/USD's calm belies mounting euro risks from bond market

Observing EUR/USD this week, one could easily believe the euro is steady and ignoring the bond market's warning signals. However, stepping back reveals that EUR/USD might not provide a complete view of the current euro risks.

The currency pair has held up reasonably well this week, currently near 1.1240 after bouncing from support around 1.1200 on Monday. Nevertheless, that resilience should not be interpreted as growing comfort among traders with Europe's fundamental issues.

In fact, the bond market signals the opposite. The France-Germany 10-year yield spread has expanded to about 161 basis points, the widest since 2011.

This spread reflects the additional compensation investors require to lend to France instead of Germany. Given France's fiscal uncertainty, political instability, and increasing borrowing costs, that premium is increasingly hard to overlook.

Yet EUR/USD has not shown a similar sense of urgency this week. Curious, isn't it?

The pair remains in a difficult position, staying below key daily moving averages and only staging a modest bounce after last week's low of 1.1113. Currently, the recovery effort is testing resistance near 1.1250-60, with the 23.6% Fibonacci retracement at 1.1254 in focus. Still, there is little indication that the broader technical outlook has improved much unless buyers can push above that and then target the 1.1340-50 region.

That said, sellers are not entirely in command to drive the pair lower and break below 1.1200 for now. So what explains the situation?

Perhaps the more telling indicator right now is EUR/CHF.

The pair has already broken below its trendline support from the March to May lows, along with the 100-day moving average near 0.9300 earlier this month. Now sellers are pressing on the 200-day moving average around 0.9235. A sustained break below that could initially open the door to 0.9200, before refocusing on the 0.9000 level.

Given that the Swiss franc typically gains when investors turn more cautious on European risks, EUR/CHF may be the best gauge of how traders are currently pricing euro risks. That suggests the euro could be near a more significant decline if conditions persist.

Returning to EUR/USD, the role of dollar sentiment may explain why the pair has not been the best indicator of euro risks this week. The dollar has weakened in recent sessions as Treasury yields remain near the sharp pullback from last week. Ten-year yields are still at 5.09%, little changed from the start of the week.

Thus, for signs of increasing trader unease about Europe's fiscal outlook, EUR/CHF and the French-German yield spread warrant much more focus than EUR/USD alone at this point.