French unrest compounds debt crisis fears

The French 10-year bond yield jumped 7 basis points to near its highest level in decades, reflecting renewed pressure on government borrowing costs as social unrest and political instability mount. The move comes as the country's benchmark borrowing costs touch their highest level since 2002, with investors demanding a higher premium to fund national spending.

In early Monday trading, the euro fell 0.15% against the U.S. dollar and 0.13% against the British pound. The CAC 40 index dropped nearly 1%, continuing a pattern of underperformance relative to European peers. The market has struggled in recent years, partly due to the dominance of luxury firms facing a downturn in high-end Chinese consumer spending, and partly due to sensitivity to the OAT-Bund spread, which has reached its highest level since the European Sovereign Debt Crisis of the early 2010s.

French yields now surpass those of Italy and Greece, a development that implies higher risk for lenders. The extra yield France pays over Germany widens concerns about the cost for companies to raise capital and heightens fears of tighter regulation and higher taxes. Mike Bell, head of market strategy at RBC BlueBay Asset Management, told CNBC's "Squawk Box Europe" that the current environment is not helpful for international investors considering French bonds. He noted that foreign ownership of French government debt has climbed significantly, moving from approximately 48% in early 2022 to close to 60% by the start of 2026, a shift that could amplify market volatility during risk-off periods.

Street protests over the weekend in cities including Paris, Lyon, and Marseille saw hundreds of thousands march against political paralysis and cost of living. The gatherings resulted in clashes with police, fires, and more than 2,000 arrests. Bell argued that France needs to address its fiscal position, including raising the retirement age, but warned that such measures could trigger further unrest given that the average life expectancy is 84 years while the current retirement age is 62.

Analysts point to uncertainty over next year's presidential election and the ability of Prime Minister Sébastien Lecornu's minority government to pass the 2027 budget as key drivers of market anxiety. Sharon Bell, senior European equity strategist at Goldman Sachs, stated that it will be difficult to reduce the budget deficit without painful measures, potentially leading to higher taxes for businesses. She added that investors remain skeptical about the prospect of fiscal consolidation and a decline in the budget deficit.

Ken Egan, senior director of sovereigns at KBRA, noted by email that auctions last week showed solid underlying demand for French debt, despite the current risk-off sentiment. He said the market question is how easily France can make progress from here. Sharon Bell said she did not believe current conditions warranted emergency intervention by the European Central Bank, which does not want to use tools like its Transmission Protection Instrument. However, she added that if spreads disrupt market liquidity, the ECB would likely use the mechanism, a move that would be politically sensitive and require stringent fiscal reforms.

RBC BlueBay's Mike Bell described France as facing a "very real risk" of its own sovereign debt crisis. He warned that before any intervention, there would be a clash between the next election winner and the ECB. The central bank is unlikely to step in unless France complies with its excess deficit procedure, which requires the general government budget deficit to not exceed 3% of GDP. France's current deficit stands at around 5%. Banque de France Governor Emmanuel Moulin told CNBC last week that rising yields were due to political uncertainty but said it was possible to return to a 3% deficit by 2029.