In a dramatic turn of events that has sent shockwaves through financial markets, the premium investors are demanding to hold French government bonds over their German counterparts has skyrocketed to levels unseen in over a decade. The widening spread, which peaked at a staggering 90 basis points on Wednesday, reflects growing fears that France’s embattled government could collapse as Prime Minister Michel Barnier struggles to push through a contentious austerity budget.
The last time the gap between French and German 10-year bond yields was this wide was during the height of the eurozone sovereign debt crisis in 2012, when concerns about a potential Greek default wreaked havoc on markets. Now, it is France, the currency bloc’s second largest economy, that finds itself in the eye of the storm.
Government on the Brink
At the heart of the crisis is Barnier’s plan to slash €60 billion in spending and raise taxes, a bitter pill that he is trying to swallow despite lacking a working majority in parliament. The veteran conservative, appointed by President Emmanuel Macron in September following snap elections that left the National Assembly deeply divided, has warned of dire consequences if his budget fails to pass.
“There will be a big storm and very serious turbulence on the financial markets,” Barnier cautioned in a television interview, painting a grim picture of what could unfold if lawmakers refuse to back his measures.
But opposition to the austerity package is fierce, with the far-right leader Marine Le Pen vowing to support a no-confidence motion that could topple Barnier’s fragile government. The political brinkmanship has investors on edge, fearing that fresh elections could be on the horizon, ushering in a prolonged period of uncertainty.
A Deficit Dilemma
The high-stakes showdown in Paris comes as France’s budget deficit is on track to exceed 6% of GDP this year, more than double the European Union’s mandated limit. With the country already under the watchful eye of Brussels, which has placed it in an “excessive deficit” monitoring program, the pressure on Barnier to rein in spending is immense.
His proposed belt-tightening aims to trim the deficit to 5% in 2025, but analysts warn that if his measures are not implemented, the shortfall could balloon to an alarming 7% – a level that would almost certainly trigger a more severe market reaction.
“This is the level when bond vigilantes start to sniff around,” noted Kathleen Brooks, research director at the trading platform XTB. “The bond market’s concerns are now focused solely on the budget and the size of the deficit.”
Macron’s Gamble Backfires
The current crisis is a bitter pill for Macron, who had hoped that calling snap elections in July would strengthen his hand after suffering a humiliating defeat in the European Parliament elections. Instead, the move backfired spectacularly, resulting in a hung parliament divided into three blocs – the left, far-right, and center – with no clear majority.
Barnier, a seasoned political operator and former EU Brexit negotiator, was meant to be Macron’s steady hand on the tiller, navigating the treacherous waters of a fractured legislature. But with opposition parties smelling blood, his grip on power appears increasingly tenuous.
Markets on Edge
As the political drama unfolds, financial markets are watching with bated breath. French stocks tumbled in Wednesday trading, while the euro slipped against major currencies. But it is in the bond market where the real action is taking place.
“The game of chicken in French politics is weighing on sentiment; will the government fail?” mused analysts at the consultancy Pantheon Macroeconomics in a note to clients. “The risk is that the far-left and far-right throw Mr Barnier’s government under the bus for not coming up with a budget they agree with, even if neither of these two factions would ever be able to agree on a new budget in the first place.”
For now, all eyes are on the French Senate, which is set to examine the budget bill next week. If Barnier can somehow navigate the political minefield and secure passage of his austerity measures, it could provide some much-needed relief to jittery markets. But if his government falls, the ensuing chaos could reverberate far beyond France’s borders, rattling the very foundations of the eurozone.
In a region still scarred by the debt crisis a decade ago, the specter of renewed turmoil in a core member state is the last thing policymakers in Brussels and Frankfurt want to contemplate. As storm clouds gather over Paris, one thing is certain: the stakes could not be higher, both for France and for the future stability of the single currency bloc.
