Either the bond markets riot or the people riot, as a CNBC headline put it this week, and France has contrived to have both.
When Paris could not agree to cut spending, the pressure moved into the bond market. When the bond market pushed back, it moved into the streets.
Some 550,000 people marched last weekend in the worst unrest the country has seen in years, and unions, students and the gilets jaunes are back on the streets today. From Sydney it looks like someone else’s farce. It is not: the bill for Paris may yet arrive in an Australian letterbox.
On Wednesday the yield on the ten-year French government bond touched 5 per cent for the first time since 2002. By Thursday, the premium over German Bunds had stretched to about 175 basis points, the widest since 2011, when the euro was last fighting for its life. Public debt stands at €3.6 trillion, roughly 119 per cent of GDP. The deficit will reach 5.4 per cent this year, and Sébastien Lecornu’s minority government is asking a hostile National Assembly for €54 billion of savings and tax rises merely to get it down to 5 per cent next year.
France has missed its fiscal targets in three of the past four years.
A presidential election arrives in the spring.
So, who saves France? Not Frankfurt, apparently. Christine Lagarde, a former French Finance Minister, told an audience in Bangkok this month that the first solution lies at home, in fiscal policy. The European Central Bank built a weapon for precisely this moment in 2022, the Transmission Protection Instrument, and has never fired it. Its conditions require the beneficiary to respect EU fiscal rules, which is awkward for a country sitting in the excessive deficit procedure. The older weapon, Outright Monetary Transactions, requires a government first to sign up to a bailout programme from the European Stability Mechanism. Picture the Élysée, months before an election, asking Brussels for a programme with conditions attached. Then picture the National Rally’s campaign the following morning.
The guarantee that may not pay
Since Mario Draghi promised in 2012 to do whatever it takes, holders of eurozone sovereign debt have behaved as though Frankfurt had quietly guaranteed them. A bond with a guarantee attached is worth more than the same bond without one, and what the market is doing now is repricing that guarantee. Its terms are conditional, its use is discretionary, and the guarantor has said in public that the first move must come from Paris. Strip the guarantee away and a French bond is a claim on a state with debt above annual output, no reliable budget majority and a restive electorate. A yield of 5 per cent is simply the market’s honest quote for that instrument.
Frankfurt, meanwhile, has every reason to wait. In a market this turbulent, holding back is worth more than acting early, which is why the ECB is expected to hold rates when it meets on Thursday and say as little about France as possible. ING’s Carsten Brzeski expects it to pause the run-off of its bond holdings quietly, and has even floated the idea that, if France keeps breaking EU fiscal rules, it might buy the bonds of almost every eurozone country except France.
But waiting has a deadline, and this one is the spring election. Moody’s bought Paris some time on Friday, holding France at Aa3 on the assumption that the 2027 budget will eventually pass. Note the outlook: still negative. A reprieve is not an acquittal.
There is also a problem of scale. The European Stability Mechanism can lend about €500 billion, and the International Monetary Fund’s entire lending firepower is about a trillion dollars. France owes €3.6 trillion. It cannot be rescued, only underwritten, and only Germany and the ECB have balance sheets large enough to do the underwriting.
GFC mark two?
The honest answer is no, not in the way 2008 was. The global financial crisis was a banking crisis built on opaque assets that nobody could value. The French problem sits in plain sight. It is sovereign arithmetic, published quarterly. The closer analogue is 2011 and 2012, when weak sovereigns and the banks that held their bonds dragged each other down. On 1 October the two-year spread between Italy and Germany almost doubled in a single session, the sharpest daily jump since 2020.
This is where fat tails matter. The central case, and plainly the one Moody’s holds, is muddle through: a budget forced through, spreads volatile, Paris limping to the election. But the distribution is not normal. In the left tail sits a sequence that is individually plausible and jointly disastrous: the budget fails, the government falls, the election delivers fiscal populism, the agencies cut France towards BBB and funds with rating limits are forced to sell, and Frankfurt hesitates one meeting too long. Expected shortfall, the average loss across that tail, is the measure that counts. Regulators learned in 2008 that averages comfort and tails kill.
The view from Threadneedle Street
Across the Channel, the Bank of England has reason to watch with a mixture of sympathy and relief. Britain’s ten-year gilt yields more than 5.3 per cent, higher than France’s, yet nobody talks about a British spread, because there is no Bund to measure it against. Britain borrows in a currency its own central bank controls. France does not.
Threadneedle Street also knows what acting looks like. In September 2022, when Liz Truss’ mini budget set off a fire sale by pension funds, the Bank bought gilts within days, called it a financial stability operation rather than a fiscal rescue, and later sold them back. One treasury, one central bank, one decision. Frankfurt answers to many treasuries, and buying one country’s bonds is a political act in all the others.
The Bank’s Financial Policy Committee noted last month that gilt and US Treasury yields had climbed to their highest since 2008, and warned that elevated hedge fund leverage in the gilt market keeps the risk of a sharp adjustment alive. That is how Paris reaches London: not through British banks holding French bonds, but through leveraged money that sells whatever it can when European sovereign risk is repriced. For Australia, which also has its own currency and a floating exchange rate, Britain is the more uncomfortable comparison. Monetary sovereignty does not abolish the bond market; it only changes the way the bill is sent. Australian government debt sits at around a third of GDP, a figure Paris would envy, but France stood at about 65 per cent before the global financial crisis. The lesson is not the level of debt. It is the trajectory.
Why Australia should care
Local market strategists have been telling Australian investors that their direct exposure to French bonds is small. That is true of the mean and beside the point in the tail. France will arrive through four other doors.
The first is the global term premium. Australian long bond yields were already around their highest since 2011 by May, as the Reserve Bank itself noted. A repricing of sovereign risk in Europe lifts the price of duration everywhere, and that feeds straight into fixed mortgage rates and the cost of Commonwealth borrowing. The average new owner-occupier loan in New South Wales is $842,000. If half a percentage point of European nerves finds its way into fixed rates, the repayment on that loan rises by roughly $275 a month, about $3,300 a year, without the Reserve Bank lifting a finger. This comes at an awkward moment. The Reserve Bank has already lifted rates four times this year, Deputy Governor Andrew Hauser has called the inflation outlook materially worse than the bank expected in August, and markets now see a fifth rise on November 3 as more likely than not. Imported tightening from Paris is the last thing Martin Place needs.
The second door is bank funding. In 2008 the majors leaned heavily on offshore wholesale markets, and Canberra had to guarantee their wholesale borrowing. They have learned. The share of Australian banks’ debt funding raised abroad has fallen from around a quarter in 2007 to just over a tenth by mid 2025. Yet the Reserve Bank itself notes that short-term debt has lately become a larger share of that international funding, and short-term money is the first to reprice when Europe freezes.
The third is the currency. The Australian dollar is currently outrunning the euro, trading around 70 US cents on expectations of higher local rates. In a genuine flight from risk, however, the Aussie stops behaving like a currency and starts behaving like a barometer of global nerves. It falls when the world is frightened, and it falls fast.
The fourth is trade. Europe is one of China’s largest export markets. A European recession reaches the Pilbara by way of Chinese factories, and it does so whatever sits in Australian portfolios.
Stress applied to a financial system does not vanish; it migrates.
In France it has travelled from the budget to the bond market to the boulevards. If Frankfurt keeps saying non, it will keep travelling, to Rome, to the euro, and eventually to the price of money in places that thought themselves safely distant.
Jim Chalmers’ message to investors in Sydney this week was that ‘in a world of ratcheting risk, Australia is more and more reliable’. Reliability is a fine thing to sell. It is not a firewall. Canberra should be asking where the stress would come to rest in Australia. The answer is on a kitchen table in Parramatta: a letter from the bank, a new repayment figure, and a family that has never owned a French bond.
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