Market Sounds "Red Alert" Before French Election as French-German Bond Yield Spread Returns to Eurozone Crisis Highs

Although there are still eight months to go before the French presidential election, the country’s assets are already showing signs of pressure.

According to Zhihu Finance APP, as one of the most closely watched indicators of bond risk, the premium for France's borrowing costs relative to Germany is approaching its highest level since the 2012 European sovereign debt crisis. The tension has also spread to the French stock market and corporate bond market, dragging their performance below that of international peers.

For investors, the core issue is how the next president, who will succeed the pro-business centrist Emmanuel Macron, will address deep-rooted economic challenges—including a fiscal deficit exceeding 5%, surging debt-servicing costs, and fragile growth teetering on the edge of recession. Both the far-right candidate Marine Le Pen and the far-left candidate Jean-Luc Mélenchon have promised to lead France in radically different directions.

These candidates (who just participated in their first debate last week) put forward proposals including: boosting spending to stimulate the economy, lowering the retirement age, writing off part of government debt, and even suspending France's fiscal contributions to the European Union.

The following are several ways in which the rising political risk in France has been reflected in the markets.

Bond Market

Bond futures trading data shows that investors have established new short positions, betting on a decline in French bond prices.

“Without a parliamentary majority, no room in the budget, and with political capital depleted—Macron is clearly unable to prevent the situation from worsening,” said Gavekal Research CEO Louis-Vincent Gave, referring to French bonds. “On the contrary, the risk lies in the possibility of a rapid deterioration.”

How to address France's mounting debt problem has dominated recent debates. Although the current government seeks to reduce the deficit, its fiscal targets have repeatedly been undermined by the fragmented parliament.

For long-term investors, the 15-year forward rate starting 15 years from now (15y15y forward rate) can exclude short-term monetary policy influences and serves to measure long-term borrowing costs. Currently, the spread between this indicator for France and Germany has approached the highest level since 2012, suggesting the market is pricing in decades of structural fiscal deterioration in France relative to Germany.

Stock Market

As for equities, the domestic revenue share of the French benchmark CAC 40 components is less than 20%, which to some extent limits the impact of political risk on earnings. However, sectors driven mainly by domestic demand—such as banking, utilities, telecommunications, and construction—often come under pressure when the France-Germany bond spread widens.

A larger spread reduces the attractiveness of French stocks, suppresses companies’ investment capabilities, and ultimately harms their competitiveness.

Goldman Sachs has compiled a basket of stocks with high exposure to French sales, including BNP Paribas, Orange, Engie, and Vinci. Last week, the index fell over 3% as political uncertainty grew, underperforming the pan-European Stoxx 600 index, which rose 0.2% in the same period.

Barclays analysis found that the risk premium already reflected in France’s blue-chip stocks is close to the stage highs of previous election cycles. Their estimate is based on the difference in March/June forward volatility between the CAC 40 and the S&P 500 index.

“This suggests that, although the election premium may continue to accumulate, current pricing already reflects a considerable degree of political uncertainty,” strategists including Stefano Pascale and Anshul Gupta wrote in a report.

Their research also shows that companies such as Air Liquide Group, AXA, and Renault Group are historically most sensitive to changes in the France-Germany bond spread, indicating these stocks could be particularly vulnerable if sovereign risk premiums widen further.

Credit Market

Bonds issued by French financial institutions have shown weakness, with their risk premium rising faster than that of the overall eurozone bank bond market over the past month. This divergence is particularly pronounced in bonds maturing within five years, while the spread at the long end has narrowed somewhat.

The worst performers are subordinated bonds—which would be the first to take losses if a bank fails.

During previous periods of elevated political risk in France, the banking sector has been one of the most volatile industries in the credit market. In 2024, Macron’s decision to call early elections triggered a surge in trading volume for major French bank bonds.

Currency Risk

The indicator measuring the risk of France leaving the eurozone is on the rise, but remains below the peaks of the past two years.

This measure is based on the differential between credit default swaps, and is still well below the levels seen during the 2017 election—when Le Pen threatened to hold a referendum on abandoning the single currency. This time, however, frontrunner Le Pen has dropped this position.

Nevertheless, this spread is worth watching, as it could act as a leading indicator of potential future tensions between France and the EU over the coming years. Left-wing politician Mélenchon (considered Le Pen’s main rival) has already proposed that France could opt not to comply with EU rules and treaties when they conflict with French interests.