BofA FX Weekly: Yen preferred for short euro positions as buffers thin for high-yielding emerging-market currencies

As French risks rise, why favor selling the euro and buying the yen?

The spread between French and German 10-year government bonds has breached 150 basis points, invalidating BofA’s previous view that it would remain below that level; mass protests have added political and growth risks.
According to BofA’s estimates for large moves, every 10-basis-point widening in the French-German spread corresponds to roughly 0.4% weakness in EUR/USD. The bank maintains its year-end EUR/USD forecast of 1.15, but sees downside risk from the situation in France.
To express euro weakness, BofA most favors buying the yen: Japan welcomes a stronger yen, and public pension rebalancing could also have a greater impact on EUR/JPY. By contrast, if EUR/CHF approaches 0.90, the Swiss National Bank would be more likely to resist franc appreciation.
There are also conditions for a near-term rebound: BofA expects the European Central Bank to refrain from actual intervention for now, but says it could ease pressure on French bonds and support the euro by emphasizing its policy tools and signaling a possible pause in balance-sheet reduction if necessary.

The resilience of US data is already fairly well priced in, while the probability of a Federal Reserve rate hike in October has fallen from a peak of around 80% at the end of September to 5%. BofA still expects a hike, albeit with low conviction, a view that differs markedly from the market’s.
If the Fed unexpectedly raises rates, short-end rates and its anti-inflation credibility could together lift the dollar. But if it pauses with a dovish tone, persistently high inflation could raise concerns about a policy error, weighing on real yields and the dollar.
The yen also faces a near-term hurdle: BofA expects the Bank of Japan to hold its interest rate at 1.25% in October. Markets have already priced in a quarterly pace of rate hikes, making a hawkish surprise difficult. As a result, USD/JPY is more sensitive to US policy in the near term, and a Fed hike could initially support the dollar.

EUR/GBP has reached BofA’s 0.84 target, while the median market forecast at the start of the year was 0.89. The earlier case for betting on a correction of pessimistic expectations for the UK has partly played out. The bank remains positive on sterling through 2027, but is taking a less aggressive short-term stance.
The constraint comes from the pricing of event risk: positive UK data surprises are already high, while the risk premium around budget day has fallen markedly. Ahead of the 28 October budget and the 5 November central bank meeting, BofA believes much good news is already priced in and budget-related volatility is low.

During the shock from the Iran war, only 11 of the 29 more liquid emerging-market currencies generated positive returns. Those that held up generally combined higher carry returns with oil-export revenues, or were subject to tight exchange-rate management; yield alone offered limited protection.
Although median expected carry returns on emerging-market currencies are now above prewar levels, the high-yielding end has contracted: the gap between the 75th percentile and the median has fallen from 5.7 percentage points to 3.7 percentage points, reducing the yield buffers of previously resilient currencies such as those of Brazil and Colombia.
Currencies with larger increases in returns mostly belong to oil-importing economies. Their expected annualized carry returns remain below 8%, leaving them vulnerable to another sharp rise in oil prices. The Egyptian pound stands out: it was already relatively weak during the war, and its yield buffer has since fallen further, making central bank support more important.
This gives BofA’s emerging-market optimism a defined horizon and conditions for selection: the bank believes much interest-rate risk is already priced in and is especially positive on local-currency market risk premiums over the next 3–6 months, while continuing to favor carry and relative-value positions.