French debt crisis: investors declare themselves “guilty” and factor in growing default risks
Faced with the prospect of a far-right or far-left president, the bond market does not see France reducing its rapidly growing debt anytime soon and has begun pricing in the possibility of a default by the euro zone’s second-largest economy.
This is according to Thierry Wizman, global FX and rates strategist at Macquarie Group. In a note published on Thursday, he said France’s cost of insuring against default is now the highest among major EU countries and the United Kingdom.
On Friday morning, the signals became even stronger as France’s five-year sovereign credit default swap reached 81 basis points. At the same time, yields on 10-year bonds rose to 4.989%, the highest since 2002, and the premium over equivalent German yields widened to 152 basis points, the highest since the 2011 euro zone debt crisis.
Wizman warned: “The signal from French CDS prices is that the widening of the OAT/Bund spread is due to a higher sovereign default risk in France. »
These indicators subsequently reached their highs, but France’s fundamentals remain worrying, with anemic GDP growth, a budget deficit estimated at around 5.4% of GDP and rising debt service costs as yields rise.
At the same time, France’s debt-to-GDP ratio is expected to rise to 122% next year, from 119% this year, and the government’s latest plan has failed to stem rising bond yields as investors doubt its credibility.
“But our instinct is also to view the sudden widening of the OAT/Bund yield spread as a ‘guilty’ verdict on the recent direction of French presidential politics,” Wizman wrote. “The problem in particular is political polarization, which has emerged – as across Europe – mainly on the issue of immigration, rather than on tax issues. But in France, neither the populist left nor the populist right are fiscal hawks.”
Indeed, far-left presidential candidate Jean-Luc Mélenchon is campaigning for the central bank to simply cancel its holdings of French debt.
And far-right leader Marine Le Pen, leading the polls in the presidential race, has proposed tax cuts and pledged to lower France’s retirement age to 60, despite the already generous pension system taking up an ever-larger share of the budget.
A runoff between the two candidates is expected next year, and Le Pen’s National Rally (RN) is seen as the likely winner.
“As such, an outright default may be a low probability event, but an RN-led presidency, with negative influence on the 2028 budget and perception of credit risk, is a high probability event, close to 50%,” Wizman added.
He also pointed out that presidential campaigns have only just begun, meaning the discourse around France’s debt, potential default and fiscal policy is about to heat up and further damage perceptions of the government’s solvency.
Of course, France is not the only one to be faced with high debt and market pressure on its bonds. The US debt-to-GDP ratio is now 100% and Japan’s is well over 200%.
But U.S. GDP growth is much more robust, and Japan enjoys ample intrinsic demand for its debt from domestic investors. In contrast, the French economy is expected to grow by just 0.5% this year, and the government plans to issue more than $380 billion in medium- and long-term debt next year.
Ales Koutny, head of international rates at Vanguard, told the Financial Times that the demand for debt in markets that become the center of geopolitical problems “can disappear in times of crisis”, calling France “degrading credit in the long term”.
Similarly, Scope Ratings also flagged political risks when it lowered France’s credit rating from AA- to A+ last month, putting it on par with Fitch and S&P Global Ratings.
The ratings company notably cited the government’s difficulties in meeting its self-imposed deficit targets, adding that the sharp rise in bond yields this year would further increase borrowing costs and make any solution to the debt even more painful.
“Scope expects political fragmentation to remain high beyond the 2027 presidential election, which would complicate the significant fiscal consolidation needed to stabilize public debt and increase the risk that measures will be diluted, delayed or only partially implemented in the years to come,” it warns. “This weakens Scope’s confidence in France’s ability to halt, let alone reverse, the deterioration of its public finances in the medium term. »
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