Street fires spread to the bond market as France's fiscal crisis is pushed to the brink

Zhichong Caijing APP noted that after a weekend of violent riots, French government bonds fell, highlighting the tension between protesters angry about the cost of living and a government unable to spend to maintain stability.

French government bonds underperformed those of other European countries, with the spread between 10-year French bonds and German bonds widening by 8 basis points to 146 basis points, the highest in two weeks. The spread with Italian bonds set a new record, while the euro weakened and the CAC 40 index dropped 1.2%.

Last weekend, a wave of attacks on public buildings, shops, and restaurants broke out across several French cities. However, with a mountain of debt and one of the highest budget deficits in the eurozone, the government cannot simply calm the public by increasing spending.

Louis-Vincent Gave of Gavekal Research said, "France today is facing a social crisis, an immigration crisis, an energy crisis, an economic crisis, and a fiscal crisis, all at once. And all of this is happening while the French president is 'in office but powerless.' There seems to be no reason to support a stronger euro or lower French bond yields after what happened this weekend."

As unrest continues, the risk premium for French bonds may rise again

Investors increasingly see French government bonds as riskier than German bonds—the latter usually being considered the safest borrower in the eurozone. The France-Germany spread is approaching 150 basis points, moving further into the range associated with the eurozone debt crisis. At the peak of the recent French bond sell-off, this spread nearly hit 160 basis points.

As the protests unfolded, French lawmakers were debating the 2027 budget proposal. The draft bill, put forward by the government, includes 43 billion euros (about 48.2 billion dollars) in deficit reduction measures. Reaching a compromise in a deeply divided parliament is already difficult—and with only six months until the presidential election, it may become even harder.

The euro once dropped 0.5% to 1.1183 dollars, the weakest among G10 currencies. Although there was a brief rebound last week, traders remain bearish on the euro's outlook, and the cost of hedging further depreciation has shot up.

Erik Lim, strategist at Commerzbank, said, "Even though the violent protests do not represent the vast majority of citizens, the developments over the weekend still highlight the government's difficult balancing act between appeasing the public and soothing the markets."

Moody’s will review France’s sovereign rating on Friday, providing another indication of the country’s fiscal health. Given its negative outlook, a ratings downgrade is considered the more likely next step. Currently, Moody’s rating for France is one notch higher than those of Fitch and S&P Global.