The French government bond market took a brief breather after last week's selloff.
On October 26 local time, the 10-year French government bond yield once fell nearly 12 basis points to 4.91%, dropping back below the 5% mark. On October 23, Moody's kept France's sovereign credit rating unchanged, easing market concerns about a downgrade, while weekend protests did not produce the severe unrest seen the previous week, also improving investor sentiment.
As French bond yields retreated, the spread between French and German 10-year government bond yields also narrowed from as much as 178 basis points last week. The spread fell to 154 basis points on Monday, reflecting a decline in the risk premium investors demand to hold French government bonds.
However, the market rebound does not mean France's fiscal risks have been removed. The French government still faces multiple challenges, including difficulty advancing the budget bill, a fragmented parliament and social protests. Moody's decision to keep the rating unchanged was also based on expectations that France can pass a 2027 deficit-cutting budget, that financing costs will ease in the coming months and that social tensions will moderate.
According to Xinhua, French President Macron told the media on the 26th that the demonstration scheduled for the 31st still carries the risk of violent conflict. He condemned social media for spreading scenes of violence and fueling violent behavior, while calling on all parties to prepare for the upcoming protests.
The 2027 budget bill becomes key, fiscal consolidation still faces headwinds
Moody's affirmation of France's rating does not mean it has turned optimistic about France's fiscal position. The rating agency made clear that one precondition for the Aa3 rating is that France can pass a 2027 budget aimed at reducing the fiscal deficit, while financing costs and social tensions ease in the coming months.
The 2027 budget proposed by the French government aims to cut the fiscal deficit to 5% of gross domestic product (GDP), below the 5.4% expected this year. But the budget bill is not advancing smoothly in parliament; opposition parties lack willingness to compromise on spending cuts, some austerity measures have already been removed during parliamentary review, and other opposing forces have proposed increasing spending.
The French government also faces social protests driven by cost-of-living pressures. In the previous week, demonstrations over insufficient school funding and living costs escalated into unrest, further highlighting the political resistance facing fiscal austerity policies.
Political uncertainty will also extend into next year's presidential election. Reuters, citing market participants, noted that the evolution of France's political situation in the coming months, and whether the government can push the budget bill through, will affect the risk premium of French government bonds relative to German bunds.
ECB decision approaches, market watches impact of high yields
As the French government bond market temporarily stabilizes, investors' attention is also turning to this week's key central bank policy decision.
The European Central Bank is expected to keep the deposit rate unchanged on October 29, and the market will focus on President Lagarde's assessment of the economy, inflation and financial conditions, as well as how the central bank views the impact of rising long-term euro area government bond yields.
Reuters reported that earlier increases in energy prices intensified inflation pressure, while rising long-term government bond yields could also tighten financing conditions. If borrowing costs for France and other highly indebted euro area countries remain elevated, government financing, bank wholesale funding and broader economic activity could all be affected.
Therefore, whether the rebound in French government bonds can continue still depends on multiple factors: whether the buffer from Moody's rating affirmation can last, whether the French government can advance the 2027 budget bill, and whether the political and social situation stabilizes further.
In the short term, the temporary fading of downgrade risk has provided breathing room for the French bond market; but with fiscal consolidation still facing headwinds and political uncertainty not yet eliminated, the decline in yields is not enough to prove that France's sovereign debt risk has substantively improved.
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