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Germany Cracks and the Euro's Old Fault Line Reopens - G10 FX Weekly - Week of September 24, 2026

G10 FX Weekly for the week of September 24, 2026. Podcast synthesis on a German state election shock reviving the euro’s dormant crisis as the France-Germany bond spread broke a 14-year line, why the desks still want to own the euro on a hawkish ECB, the yen’s credibility problem after its split hike, Japan rattling its sabre near 158, the carry trade, and sterling as the favored major.

G10 FX Weekly

Week of September 24, 2026: Germany Cracks and the Euro's Old Fault Line Reopens

For weeks this newsletter has treated Europe as the quiet corner of the map, a currency people borrow rather than own, with a couple of slow-burning risks smoldering in the background. On Monday we said those risks were "still glowing." Over the weekend they caught fire.

A single German state election handed the governing party a humiliation, the chancellor went on television and called it "a total disaster," and the gap between what France and Germany pay to borrow blew through a line it hadn't crossed in fourteen years. None of it is a crisis yet. But the thing about Europe's fault line is that it stays invisible for months and then moves all at once, and this week it moved. Meanwhile the yen story we've been living inside didn't go away; it just matured from "did the hike work?" into the more dangerous question of whether the whole borrow-cheap-yen machine is about to seize up. Let's get into it.

TL;DR

  • Germany's government got a shock, and the euro's dormant crisis stirred. In the state of Mecklenburg-Western Pomerania, exit polls showed Chancellor Friedrich Merz's CDU winning just 5% of the vote, a "pretty shocking outcome," per NAB's Sally Auld, who noted Merz broke protocol to admit "effectively it was a total disaster" (NAB Morning Call, Sep 20).

  • The France-Germany bond spread broke a 14-year line. It "posted its biggest single-day jump in more than two years and pushed through that psychological 100 basis points level for the first time in 14 years," said Auld, after France's finance minister admitted the widening was "due to budget issues" (NAB, Sep 20). By Monday it had crept to roughly 105bp (Saxo Market Call, Sep 21).

  • Yet the desks still want to own the euro over the next year. J.P. Morgan added a fourth ECB hike, in March, to its base case; MUFG sees the ECB peaking at 3% and EUR/USD around 1.20 by the middle of next year (Global Data Pod, Sep 18; MUFG Global Markets Podcast, Sep 18). The politics are the wildcard, not the base case.

  • The yen's problem is now credibility, not the rate. "We've had a bigger move in dollar-yen after the BOJ meeting than we did after the Fed meeting," Bank of America's Dars Simha pointed out, the market punished a rate hike harder than it reacted to the Fed, because Japan's tightening no longer looks fully committed (Global Research Unlocked, Sep 18).

  • Japan is quietly rattling its sabre near 158. Dollar-yen pushed toward 158 and then snapped back as reports of official "rate checks", a classic pre-intervention warning shot, hit the wires (NAB, Sep 20). The catch: J.P. Morgan says Japan's ammunition is "limited" after spending ¥17 trillion this year (At Any Rate, Sep 18).

  • The carry trade is the elephant in the room. On The Rest Is Money (Sep 20), Patrick Boyle warned the unwind is a "slowly, slowly, then all at once" event that can wipe out "two years' worth of gains in a day," and called US policy toward the yen flatly "incoherent."

  • Sterling stays the desks' favourite major, and a genuinely fresh wrinkle emerged on the Bank of England's bond-sale freeze: it may be less bullish for gilts than Monday's rally suggested (more below). A "blowout" retail sales beat keeps a November UK hike firmly in play (NAB, Sep 20; Global Data Pod, Sep 18).

  • The franc is still the market's designated funding currency, and the Swiss National Bank decides today. The desks expect a hold at zero; the real thing to watch is whether it softens its language on defending the currency (Nomura – The Week Ahead, Sep 18).

What's new

1. A German state election lit the fuse under Europe's oldest fear

Start with the human story, because it's genuinely striking. Germany held a state election in Mecklenburg-Western Pomerania over the weekend, and the result was a disaster for the party that runs the country. As NAB's Sally Auld relayed on NAB Morning Call (Sep 20): "We don't have the full results, but the exit polls suggest that the governing CDU party only won 5% of the vote, which is a pretty shocking outcome."

Five percent. That's the line a party has to clear just to hold seats in a German parliament at all. And Chancellor Friedrich Merz, leader of that same CDU, did something politicians almost never do. As Auld put it, he "broke with a protocol, which is that you don't really speak the day after an election," and admitted "effectively it was a total disaster. So question marks are being asked about the sustainability of his leadership." He also cancelled a trip to the United Nations to deal with the fallout at home.

Why does a regional vote in northern Germany matter to a currency book? Because it feeds the one European story that never fully goes away: fiscal and political fragility. Nomura's Josie Anderson had flagged the danger before the vote, noting the far-right AfD was polling strongly and that "you're seeing increasing headlines of people raising the possibility of a chancellor swap" (Nomura – The Week Ahead, Sep 18). Her base case is still that a snap national election is unlikely, no mainstream party wants to hand the AfD a bigger stage, but the direction of travel is now a market factor, not just a political one.

2. The bond market said the quiet part out loud

Here's where the politics turned into a number traders can't ignore. The clearest read on Europe's health is the gap, the "spread", between what France and Germany pay to borrow for ten years. Germany is the eurozone's safe borrower; France is the shaky one. When that gap widens, it means investors are getting nervous about France specifically, and about the euro project generally.

On Friday it didn't just widen, it jumped. In Auld's words, the spread "posted its biggest single-day jump in more than two years and pushed through that psychological 100 basis points level for the first time in 14 years" (NAB, Sep 20). French ten-year yields rose 12 basis points on the day; German yields barely moved. And the trigger was almost startlingly honest: France's own finance minister "later in the day on Friday did acknowledge that the spread rise was due to budget issues, which in itself is a little bit concerning."

A hundred basis points is not a random number. It's roughly the level John Hardy of Saxo Bank had warned about on Monday's material: "This thing needs to stop around 100," he said, or "there will be a lot more focus on that and talk of a new EU sovereign debt crisis or at least the need for some kind of official response" (Saxo Market Call, Sep 18). It did not stop at 100. By Monday it had drifted to about 105bp (Saxo Market Call, Sep 21). This is the number to keep on your screen all week, it's the euro's smoke alarm.

3. The twist: the currency desks still want to own the euro

You'd think all this would make the euro a sell. It's not, at least not on the twelve-month view, and that tension is the most interesting thing about the euro right now.

The reason is interest rates. The European Central Bank has swung from cutting to hiking, and the desks keep adding more hikes to their forecasts. J.P. Morgan's Allan Monks was blunt about how fast his own view is changing: "I changed the call again this week on the ECB, having changed it a couple of weeks ago to put in the hike for December. I've now put in another one for March, so total of four now", with a possible fifth in June (Global Data Pod, Sep 18). His worry is that inflation simply won't behave: even in 2028, core inflation looks "still very sticky, three, four tenths above the target." When growth is decent and inflation is sticky at the same time, he noted, the old agonised debate about whether to cut rates disappears, "it's no longer as debated about what to do with rates." You hike.

MUFG's Derek Halpenny frames the payoff for the currency. His firm now has "the ECB moving two more times to a peak policy rate of 3%," and on that basis, "if the ECB delivers as we expect, then the grounds are still very much there for expecting the euro to move higher and reach those levels by the middle of next year", roughly 1.20 on EUR/USD (MUFG Global Markets Podcast, Sep 18).

So hold the two ideas together: higher ECB rates argue for a stronger euro over the next year, while French budgets and German politics argue for a weaker one right now. The base case is the rate story; the political mess is the thing that could derail it. That's the euro trade in a sentence.

4. The yen: it's not the rate anymore, it's the credibility

The Bank of Japan raised rates to a 31-year high last Friday, and the yen fell, the story Monday's issue was built around. This week the market chewed on why, and the answer that's emerging is uncomfortable for anyone still betting on a stronger yen.

Bank of America's Dars Simha put his finger on the single most telling fact of the week: "We've had a bigger move in dollar-yen after the BOJ meeting than we did after the Fed meeting" (Global Research Unlocked, Sep 18). Sit with how strange that is. Japan tightened policy and its currency reacted more violently, and in the wrong direction, than it did to the US central bank. The reason, Simha argues, is that the split 7-2 vote, with two dissenters appointed by the reflation-minded prime minister, "does challenge" the market's assumption that Japan's central bank, its finance ministry and the US Treasury are all rowing in the same direction. "That's why the yen sold off so much more than the rates market move would have implied." His verdict: "near-term FX credibility has taken a bit of a hit," and "there will certainly be less appetite in the near-term to bleed carry to be long the yen."

HSBC's chief Asia economist, Fred Newman, made the same point from a different angle on Squawk Box Europe Express (Sep 17). To him it was "a bit of a missed opportunity for the BOJ, sending that slightly more dovish signal," and the mechanism is simple: "It's about the relative hawkishness or dovishness among central banks." When one central bank looks committed (the Fed) and another looks divided (Japan), "the currency is the one that takes the brunt of the pressure." Newman still sees Japan's rate ceiling, its "terminal rate", at around 1.75%, but the path there now looks shakier than it did a week ago.

Not everyone is bearish the yen. Bank of America's Japan rates strategist kept a December hike as the baseline, noting the market has "largely priced out an October hike, with the implied probability falling to around 18 percent" while shifting bets to December (Global Research Unlocked, Sep 18). And Nomura actually brought forward its hike calls to December and March, with a scenario for a 2.0% ceiling if oil stays high (Nomura – The Week Ahead, Sep 18). The structural case for a stronger yen isn't dead, it's just been pushed out and made to prove itself.

5. Japan rattles its sabre, but the gun may be half-loaded

While the strategists debate, Japan's finance ministry is watching one number: dollar-yen near 158. And this week it started making noise.

As Auld described it, dollar-yen "pushed up towards that 158 level in early London trade," then the yen "rallied a bit later on as various news sources were reporting that there were some rate checks going on in the dollar-yen market, which the market basically takes as a signal that some intervention might be coming" (NAB, Sep 20). A "rate check" is exactly what it sounds like, officials phoning around to banks asking where the currency is trading. It buys nothing, but it tells the market: we're watching, and we might act.

The problem is that Japan may not have the firepower to back the threat. J.P. Morgan's Junya Tanase laid out the constraint plainly: Japan "has already conducted about 17 trillion yen of FX intervention this year, and its FX reserve has fallen by roughly 15%," so "Japan's remaining room for further intervention from here is limited" (At Any Rate, Sep 18). He sees dollar-yen trading in a 155-165 range and doesn't expect real intervention "unless it approaches or breaks above the recent high at 164." Even then, there's a catch worth remembering: when the US helped Japan intervene in July, it did the buying in euro-yen, not dollar-yen, because Washington's top priority is a calm US Treasury market, not a strong yen. So don't assume America rides to the rescue at 160.

Auld added a note of scepticism about whether intervention would even work right now: "intervening when markets are still questioning the Bank of Japan's resolve does feel a little bit self-defeating." You can't buy credibility with dollars.

6. The carry trade, the thing under everything, gets a plain-English warning

The reason the yen matters far beyond Japan is the "carry trade," and this week it got the clearest explanation of the cycle so far, on a mainstream podcast aimed at ordinary listeners. On The Rest Is Money (Sep 20), finance commentator Patrick Boyle walked through it: "The world has gotten used to borrowing yen at next to 0% interest rates in order to fund other investments... you might borrow Japanese yen and buy a US dollar treasury bond. If the treasury is paying 4% and you're borrowing at 1%, you're picking up a 3% interest rate for essentially doing nothing."

That works beautifully, until it doesn't. Boyle's description of how it ends is the sentence to remember this week: "People feel a little bit squeezed, they unwind a bit more, they feel their unwind squeezes them more... and then suddenly they just need out. Most of the time it works, but then every once in a while it does a sharp reset. And so you might have two years' worth of gains that get wiped out in a day." That's not a hypothetical, it's roughly what happened in August 2024, and it's the tail risk that sits under every "borrow yen" position on the planet.

He also landed the sharpest critique of US policy anyone offered this week, that Washington is trying to do two opposite things at once: "forcing Japan to move money into the United States, which involves selling yen and buying dollars, which weakens the yen. They've got the tariffs, which weaken the yen. And then they're trying to support the yen. This is kind of incoherent, and it's not going to work." Whether or not you agree, it's a useful reminder that the official "we want a stronger yen" line is fighting several other official policies pulling the other way.

7. Sterling stays the favourite, but the gilt story got a footnote

The pound remains the desks' preferred major, for a simple reason: it pays you to hold it and the UK economy keeps surprising to the upside. J.P. Morgan's Octavia Popescu keeps calling sterling "a relative high-yielder within G10" where "growth has continued to beat expectations" (At Any Rate, Sep 18). The evidence kept coming: UK retail sales rose 0.6% in August against expectations of a fall, which Auld said "does very little to deter the market from expecting a rate hike from the Bank of England in November" (NAB, Sep 20). Both J.P. Morgan and MUFG expect that November hike, MUFG's Halpenny says the bank is "being set up for a move in November... unless there's a dramatic drop in energy prices" (MUFG, Sep 18).

But here's the fresh, genuinely useful wrinkle, and it slightly deflates Monday's story. On Monday we cheered the Bank of England's decision to freeze its bond sales as clean good news for the UK debt market. Bank of America's rates desk poured a little cold water on that. Yes, pausing the bank's own sales removes a source of selling pressure. But the government still needs to raise the same amount of money, so the bonds have to come from somewhere: "The net value of gilts to be absorbed by the market from active sales will be the same. We will get an extra 20 billion gilt sales from the DMO rather than 20 billion from the bank" (Global Research Unlocked, Sep 18). In plain terms: the seller changes, the supply doesn't. The relief rally in long-dated gilts was real, but the underlying pile of debt the market has to swallow hasn't shrunk. That matters going into the autumn budget.

And there's a genuine two-sided debate on the UK rate path. Against the November-hike consensus, Nomura is the house contrarian, sticking with no Bank of England hikes for the rest of 2026, Josie Anderson notes the market is pricing "around 38 basis points by the end of the year, quite different to our view of no change in rates," and pins the whole call on whether energy prices (and the Iran war driving them) come back down (Nomura – The Week Ahead, Sep 18). If Nomura is right and everyone else is wrong, the sterling-bull trade loses its main engine.

8. Switzerland: the franc keeps funding, and the SNB decides today

The Swiss National Bank makes its rate decision today, and the message from the desks is: don't expect drama. A hold at zero is the near-universal call. The one thing worth watching, per Nomura's Josie Anderson, is the language on defending the currency. She expects the bank may "change its wording back to a more typical statement that the SNB remains willing to be active in the FX market as necessary," softening from its previous "increased willingness to intervene" (Nomura – The Week Ahead, Sep 18). The reason is quietly important: "the franc has depreciated notably over the past six months, which has eased prior deflationary pressures." A weaker franc has, in effect, done the central bank's job for it, a year ago Switzerland was staring at deflation and a possible return to negative rates; now, with a bit of energy-driven inflation, the picture is comfortable.

That leaves the franc exactly where it has been all cycle, the lowest-yielding major, the currency you borrow and sell. J.P. Morgan is explicit that it stays "bearish Swiss," with inflation "at 0.8% on the headline," and doesn't expect the meeting to "upset Swiss funding" (At Any Rate, Sep 18). (One honest caveat: no podcast this week previewed the parallel Riksbank and Norges Bank decisions, so we're leaning on the standing carry framework there, Sweden's krona in the "funder to sell" bucket, Norway's krone in the "high-yielder to own" one.)

The debate

Fight 1: Is Europe's wobble a buying dip or the first tremor of something worse?

The bullish case is almost entirely about interest rates. The ECB has turned hawkish, the desks keep adding hikes (J.P. Morgan now at four, MUFG at a 3% peak), and higher rates plus sticky inflation are a recipe for a stronger currency over the next year, hence MUFG's 1.20 target on EUR/USD. On this view, the German election and the French budget are noise: real but survivable, the kind of thing that creates a better entry point rather than a reason to bail.

The bearish case is that the smoke alarm just went off. The France-Germany spread breaking a 14-year high, on the same weekend the German chancellor's party collapses in a state vote and he calls it a "total disaster," is not the sort of thing that resolves quietly. Hardy's warning is the one to respect: past roughly 100bp, and certainly past 105, the market starts "talk of a new EU sovereign debt crisis." The honest read: the rate story is the base case and it points the euro higher, but the political tail just got fatter, and the euro is uniquely exposed to a story, sovereign fragmentation, that has no clean floor once it starts.

Fight 2: Is the yen's rally dead, or just delayed?

The bears have this week's tape. A tightening central bank whose currency falls harder than it did after the Fed (Bank of America), a "missed opportunity" to sound hawkish (HSBC), a positioning squeeze, and a finance ministry with a half-empty tank. Credibility, once dented, is slow to repair.

The bulls say wait. Nomura pulled forward its hike calls; Bank of America keeps December as the baseline; and the structural logic, Japan normalising, the carry trade slowly deflating, is intact, just delayed. Tanase's own 155-165 range isn't a collapse; it's a currency stuck in a box. The tie-breaker is the carry trade itself: as Patrick Boyle reminded everyone, these things unwind "slowly, then all at once." A drift toward 158-160 is a delay for the bulls; a violent snap back through 150 would be the structural case arriving whether Japan wants it or not.

Trades in play

Drawn from what the desks actually said, ranked by usefulness for a book:

  • Watch the France-Germany spread as the euro's master switch. The medium-term rate story favours a long euro (MUFG's 1.20), but the entry is hostage to the spread. A sustained hold above ~105bp is the signal that the political story is overwhelming the rate story, and the moment to stand aside on euro longs, or fade any euro strength.

  • Respect the dollar-yen squeeze, but don't chase it into 160. The path of least resistance is higher after a dovish hike and a credibility knock, but rate-checks are live and J.P. Morgan flags 164 as the real intervention trigger. Size this for a violent two-way move; 158 is the referee.

  • Stay long sterling versus the low-yielders (franc, Swedish krona). J.P. Morgan's core relative-yield play, backed by the retail-sales beat and a likely November hike. The risk to flag your PM: Nomura's contrarian "no hikes in 2026" call, if energy rolls over, sterling's yield edge narrows fast.

  • Borrow the franc. With the Swiss National Bank content to let a weaker franc do its work and inflation at 0.8%, it remains the cleanest funding currency in G10.

  • "Bullish beta, bullish carry, bullish dollar", but with a growing asterisk. J.P. Morgan's Popescu is sticking with the carry playbook ("keep calm and carry on"), long Norway's krone and sterling, short franc and Swedish krona, yen as a funder. But Bank of America is now the counterweight, cautious that the dollar breaks to new highs given that everyone is hiking together. When the two biggest FX desks split, that's your cue to trim conviction, not add it.

Read-throughs

  • Bonds are the whole story this week. French ten-year yields led Europe higher (+12bp Friday) while German yields sat still, pushing the spread through its 14-year line. Long-dated UK gilts had rallied on the Bank of England's sale freeze, but Bank of America's point that net supply is unchanged (the debt office simply sells what the bank now won't) means that relief may not last into the budget. Keep the France-Germany gap and the UK long end on the same screen.

  • Euro-yen and euro-franc. Euro-yen is the cleaner "stronger yen eventually" expression than dollar-yen because it sidesteps the dollar's post-Fed tailwind, but it now carries Europe's political risk on the other leg, which cuts both ways. On the franc: a currency that has weakened for six months is quiet good news for Switzerland's big exporters, Nestlé, Roche, Novartis, Swatch, Richemont, ABB, and takes the pressure off any euro-franc floor.

  • The Nikkei likes a soft yen. The mechanical read-through holds: a weaker yen is a tailwind for Japan's exporters (the Nikkei has been trading above the 65,000 handle) and a headwind for yen-funded carry baskets the moment volatility spikes. The thing that turns a soft yen from tailwind into disaster is a carry unwind, Boyle's "all at once."

  • Volatility is the trigger to watch. The whole carry structure is calm until it isn't. If bond-market volatility (the MOVE index) or equity volatility (the VIX) jumps on the back of the European bond story, that's the spark that can force the yen-funded carry trades to unwind, the read-through that connects a German state election to a Tokyo currency crisis.

What changed

One region changed the whole mood. For weeks Europe was the boring corner of this newsletter, the euro a funding currency, the risks "smoldering." This week they stopped smoldering: a German state election humiliated the governing party, the chancellor called it a "total disaster," and the France-Germany spread broke a line it hadn't crossed since the last euro crisis. The euro's story now has two engines pulling in opposite directions, a hawkish ECB pointing it toward 1.20, and a political fault line that could open under it.

The through-line from Monday is intact but deepened. The yen story didn't reverse; it matured. Last week's question was "did the hike work?" This week's is sharper and scarier: has Japan lost enough credibility that its own rate hikes no longer support its currency, and if the borrow-cheap-yen machine seizes up, does it take the rest of the world's risk assets with it? Sterling is still the desks' favourite, but the gilt-freeze cheer got a sober footnote. And the franc keeps doing what it always does: nothing, quietly, while everyone borrows it. The next real tests aren't rate meetings, they're a bond spread in Europe and a moving average in Tokyo.