France is currently under significant pressure from both energy inflation and fiscal credibility concerns.
As the global crude benchmark Brent crude price broke through $110 and European natural gas futures rose about 4% to their highest level since December 2022, the yield spread between French and German ten-year government bonds widened to as much as 159.4 basis points, a 15-year high; after the French ten-year yield rose above 5%, the euro also weakened in tandem.
Second-quarter public debt reached 119% of GDP, and the government plans to reduce the deficit ratio from an estimated 5.4% this year to 5% next year.
However, in Paris and across France, public outrage over the rising cost of living and cuts to public services and social welfare has triggered sustained violent protests and riots, with localized curfews in Paris and other areas, further increasing resistance to the French government's deficit reduction efforts.
The European Central Bank raised its deposit rate to 2.50% in September; an October Reuters survey showed that economists largely expect a pause in rate hikes on October 29 and another 25 basis point increase in December, while interest rate futures market pricing on the 21st still pointed to an ECB rate hike in December.
From this perspective, persistent energy inflation is pushing up long-term eurozone government bond yields and the future interest rate outlook, while declining fiscal consolidation credibility continues to increase France's market risk premium; the trajectory of high interest rates and high yields is gradually raising refinancing burdens, yet deficit reduction is constrained by social pressure.
Market trading focus is increasingly concentrated on whether budget planning can restore credibility, and whether fiscal deficit and sovereign debt pressures will spread to large commercial banks' asset portfolios and financing systems.
Oil Rises to $110, Budget Concerns Deepen, French Government Bond Risk Hits 15-Year High
As energy price increases heightened concerns about France's fiscal outlook, an indicator measuring the risk of French government sovereign bonds rose to its highest level in 15 years.
The extra yield that fixed-income investors demand to hold ten-year French government bonds rather than German government bonds of the same maturity rose by as much as 6 basis points to 159.4 basis points.
This spread is regarded as a key indicator of eurozone credit risk.
Since late September, the spread has widened sharply as doubts grew over whether France can push through a budget to address its debt burden.
Over the weekend, public anger over the cost of living turned into violent protests, further intensifying concerns.
"As attention shifts back to the upcoming budget vote, the spread may remain under pressure," said Pooja Kumra, senior European rates market strategist at TD Bank in London.
"Even if the budget passes, investors remain worried about broader fiscal dysfunction and signs of political fragmentation."
As shown in the chart above, France's government bond risk indicator continues to surge — the borrowing premium of the French government bond market relative to Germany is approaching 160 basis points.
On Wednesday, rising energy prices further drove sharp volatility in European bond markets, with European benchmark natural gas futures rising about 4%, while Brent crude oil prices once again exceeded $110 per barrel.
Earlier on Wednesday, Deutsche Bank CEO Christian Sewing said France's fiscal and political instability is worth worrying about, and market volatility could persist until next year's presidential election.
The French ten-year government bond yield rose above 5% for the first time since 2002.
The euro underperformed most G10 currencies, falling as much as 0.2% to $1.1214 per euro.
France's parliament is deeply divided, and reaching a compromise on next year's budget to get the relevant legislation passed is becoming a difficult process.
With only six months until the presidential election, this process is unlikely to become easier.
Historical Mirror — The Old Transmission of the Eurozone Debt Crisis
In the previous eurozone debt crisis, the financial crisis exposed Greece's fiscal misreporting and real estate and banking risks in some countries; falling government bonds damaged banks, government bailouts of banks further increased debt, and austerity and recession worsened debt repayment capacity.
Rescue mechanisms, Greece's debt restructuring, and the European Central Bank's 2012 pledge to protect the euro gradually curbed panic.
The PIIGS refers to the five European countries of Portugal, Italy, Ireland, Greece, and Spain, a derogatory term used on Wall Street for five European economies with relatively low sovereign debt credit ratings.
However, the country that could trigger a new round of the eurozone debt crisis this time is not the PIIGS, which have long been at the bottom of Europe's economy, but France, the eurozone's second-largest economy.
As Europe's second-largest economy, France's government bond market is far larger in scale and influence on the entire European and global economy than the PIIGS that ignited the eurozone debt crisis fourteen years ago, and more and more investment institutions worry that continued heavy selling of French government bonds could have spillover effects that trigger a new round of euro depreciation crisis and eurozone debt crisis impacting global financial markets.
Looking back at the previous eurozone debt crisis — in 2009, Greece significantly revised up its fiscal deficit, and the post-financial-crisis recession and bank bailout burdens further exposed member states' fiscal fragility, with pressure subsequently spreading to Ireland, Portugal, Spain, and Italy.
Falling government bonds weakened bank assets and financing capacity, while bank bailouts increased government burdens, forming a "sovereign-bank vicious cycle"; fiscal austerity further suppressed growth.
European rescue mechanisms were gradually established, and market confidence only gradually recovered after then-ECB President Draghi pledged in 2012 to do "whatever it takes" to defend the euro and the ECB launched the conditional Outright Monetary Transactions tool.
The progress bar of France's government bond market selloff and fiscal credibility crisis is not yet sufficient to determine that a full-blown crisis is repeating — European banks currently have stronger capital buffers, and the ECB has the Transmission Protection Instrument, but intervention must assess fiscal and debt sustainability and is not an unconditional backstop.
The real signal of an escalating French fiscal and government bond crisis is when the wave of French government bond selling and the budget deadlock evolve into a eurozone liquidity crisis triggered by commercial banks' government bond asset portfolios and blocked financing processes, which then transmits through banks to other member states.
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