The French Bond Blow Out

Over the last 12 months, interest rates have been on the rise and bond markets have sold off, with investors further penalising countries with weak and fiscally loose budgets. In Europe, the prime focus has been on France, where a minority government is unable to tackle any of its deep-seated fiscal problems, let alone its social issues.

France has run a fiscal deficit for decades—in fact, the last time it ran a (small) surplus was 1974. Government debt as a proportion of gross domestic product (GDP) has been rising steadily since 2000, with additional acceleration during the global financial crisis of 2008-2009 and the more recent COVID-19 period.

Government expenditure as a proportion of GDP was higher than its main competitors, more than 50% of GDP over this entire period.

Successive governments have tried to tackle the deficit and the activity of the state, principally by focussing on pensions and health. These have mostly been met by strikes and disruption; in 1995, pension reform for civil servants was brought to an end after three weeks of strikes that brought the country to a standstill. Further reforms were passed under Jacques Chirac in 2003 and Nicolas Sarkozy in 2010, raising the pensionable age to 62 and requiring contributions to 40 years. But since then, further reform has proved elusive and constantly met by opposition from political opponents. The most notable is the RN (The right-wing party led by Marine Le Pen) but also a broad coalition on the left. Macron’s attempt in 2023 to force through reform by bypassing parliament using presidential decree led to widespread demonstrations.

As a result, Macron made another grave error in calling an election in 2024 to recover his mandate for reform. Instead, he suffered a large defeat, and the election left the Assembly (parliament) split into thirds, of right, hard left and centre MPs. This meant passing a meaningful budget became impossible. Deficits have drifted higher ever since, in sharp contrast to Italy, and with the presidential and Assembly elections in May and June of 2027, there is no incentive for the right or the left to each propose its own agenda to find a solution. This weakness is what has driven bond rates and spreads higher.

So what happens next? By law, a budget must be proposed by 13 October. If after 70 days, nothing is passed, the government falls, and at that point the constitution kicks in. This forces the tabling of a “loi spéciale” which authorises a technocratic administration to continue to collect taxes and to keep spending at last year’s level. This happened in 2025 and in 1979. Taxes will actually rise, as there is no indexation of income tax bands. Spending will not be cut or repurposed, as it remains index-linked. This is particularly important for the defence sector, where increases were expected to be funded by cuts rather than from other parts of the budget. Automatic indexation of pensions, health care and interest costs still occur, so as a result, the deficit will stay at 5.4% of GDP in 2027, if not rise.

Bond markets do not like uncertainty, especially if that uncertainty comes with the likelihood of a radical shift in policy after the May elections. The French voting system, which has two rounds if no candidate wins 50% of the vote in the first round, famously favours the centre ground. The top two candidate enter the runoff and if one is a centrist, voters will generally swing behind them as a vote against extremism. The perfect example is the 2002 presidential election. In the first round, sitting President Chriac achieved the worst-ever result of just 19.9% of the vote. The late Jean-Marie Le Pen (the father of Marine Le Pen) won 16.9% and Lionel Jospin, then the prime minister, failed to make the second round with 16.2%. In the second round, Chirac defeated Le Pen 82.2% to 17.8%, the largest margin of victory ever. This process is repeated in every constituency across the country.

Except now there is a real prospect that the top two candidates in the first round in the May 2027 election will be the right-wing Marine Le Pen and the hard-left Jean-Luc Mélenchon. This, plus the Assembly election that would follow, means that the new president probably would be able to form a government that could actually enact policy. This is where the bond market is facing a choice between two uncertainties, alongside heavy continuing issuance plus the maturing—and thus renewing—of heavy levels of COVID-issued debt.

So what are the policies of the two sides? The RN, to counter the accusation of not being trusted with the finances, released a plan on 6 October. Its centre piece is a new law, a constitutional golden rule, to reduce the public deficit by 0.5% each year, and aim for 60% debt-to-GDP. The RN is proposing €140 billion of savings by 2032 and asserting the deficit would fall to below 3% by 2030. This would then cut debt to below 112% in 2032, thus allowing room for tax cuts of up to €30 billion. There are no cuts to pensions; rather, a large estimated rebate from the European Union, a crackdown on benefit fraud, abolishing public agencies and departments, and restricting benefits to non-citizens. On the other side of the ledger, there’s spending: VAT cuts on energy and fuel bills, scrapping production taxes, and the removal of benefits from non-French citizens. A number of analysts have said that these numbers are hard to make add up—how large are these savings really, and by when? The spending is more obvious and more immediate. With the repricing of cheap COVID-era debt leading to a substantial rise in interest costs, the target of reducing the deficit by 0.5% each year looks like a stretch goal.

In contrast, the left, spearheaded by its longstanding “enfant-terrible” Jean Luc Melanchon, does not have a deficit plan. As the leader of a coalition, there is always uncertainty, but the common ground is the deficit, a result of the under-taxation of the wealthy and weak growth. The key budget policies are a wealth tax, a 2% “Zucman tax” on billionaires each year, capital gains taxed at income tax rates, and reform on inheritance taxes to limit a maximum an individual can inherit from an estate, with the rest going to the state. It is claimed these policies could raise around €50 billion a year, which would all be spent on indexing the minimum wage, reducing retirement age to 60, and expanding the public sector and green investment plan. As for debt, the European Central Bank (ECB) holds around 18% of French debt, and this would be converted to zero coupon perpetual debt. (Effectively writing it off) The ECB would then buy debt directly from the Bank of France, thus financing it via monetary expansion—a clear breach of the ECB’s own rule book.

This would cause the budget deficit to widen to around 7% in 2027 and rise further to 8.4% in 2030, leaving debt-to-GDP above 130%. Any compromise to the ECB’s independence would have major implications across the European financial system. And, it would cause interest rates to rise and the currency to weaken. After the hard-won gain in Italy, for instance, one would have to ask: Why would the ECB or the Germans agree to such a proposal?

Before the euro, the national currency would have taken the strain, but not so much the bond market. The French franc would have been the mechanism to absorb such risk; in the first two years of the Mitterrand presidency, the currency was devalued three times until Jacques Delors stepped in as finance minister in 1983 and imposed the “tournant de la rigueur,” cutting spending, raising taxes and tightening credit. From then on, the ‘Franc Fort’ was established.

So this crisis is not new to France. We were here 45 years ago. The political uncertainties largely exist because of Macron’s failures, and in particular the 2024 election, which resulted in hung parliament without a stable majority. But the street protest against pension reforms actually started in 1995, when Macron was just 18. A new government will appear in May/June and may well have a mandate to stabilise the fiscal and debt position. If it does not, the market will likely impose it. And that uncertainty will remain to be exploited until then—and perhaps beyond.