Investors have stopped assuming France will muddle through. The country's 10-year yield climbed to roughly 4.93% on Friday, a day after the government published its 2027 budget. The extra yield investors demand over German bunds approached 1.5 percentage points, close to the record from the euro sovereign debt crisis in 2011.
The sell-off began in the United States. Yields rose through September as expectations for the Federal Reserve shifted sharply, after the Fed raised rates last month for the first time in three years. France was among the worst affected. By Thursday the US market had stepped back from its most hawkish rate forecasts, yet French spreads kept widening. The move out of French bonds and into bunds has taken on a momentum of its own.
In Japan, Sumitomo Mitsui DS Asset Management sold its entire holdings of French government bonds and shifted into bunds and Japanese debt. The euro is at a 16-month low against the dollar, and hedge funds are adding bets against it.
The 2027 plan targets a deficit of 5% of GDP, down from 5.4% this year, with a consolidation effort estimated at 54 billion euros. The independent fiscal watchdog immediately called its growth assumptions optimistic.
Investors are also looking past the budget to next spring's presidential election, where candidates of the hard left and hard right appear to have a strong chance. This is the last budget before that vote. Worries about missed deficit targets, policy gridlock and the election are fraying nerves. European stock markets fell on Thursday even as US equities rallied.
The usual assumption is that the European Central Bank would step in if markets turned disorderly. That is harder to justify with euro-zone inflation at a three-year high and further rate rises already expected.
The political risk is as large as the financial one. Writing in Bloomberg, John Authers said the spark for the crisis was lit in the US, but "European voters get to decide whether it detonates." His base case is that the episode ends like earlier ones, with the can kicked down the road. Others warn of wider damage: if Paris cannot get a grip on its budget, contagion, erosion of fiscal rules and weakened leadership could spread across a bloc already struggling with slow growth.
The French budget is no longer a domestic matter. If the 10-year yield crosses 5%, France would pay more to borrow than at any point in more than two decades, just as Brussels asks every capital to finish its budget by mid-October.
Three things to watch: whether the ECB signals it would act against disorderly spread widening, how parliament handles the cuts, and whether Rome and Madrid get dragged into the same repricing. For French households and firms, higher sovereign yields feed through to mortgage and business loan rates. That slows the very growth the budget is counting on.
