The dreaded moment has arrived where political chaos catches up with the economy.
At a time when interest rates are skyrocketing, France is being criticized for a budget it cannot seem to control. The government lacks a majority in the National Assembly to pass it, and next May, a new president will take office at the Élysée Palace. And, inevitably, his budgetary strategy is not yet clearly defined.
The role of foreign investors
International investors are questioning the future outlook for French public finances. The projected trajectory of French debt appears to be still trending upwards, with the budget remaining in deficit at 5% of GDP according to the initial 2027 budget law.
These investors need to position themselves on French risk. For France, this issue is all the more pressing given that French debt is held primarily by non-residents.
A shift in expectations in Milan, Tokyo, or New York would have a strong and lasting effect on interest rate profiles. Germany has long been the anchor of French financial dynamics. The divergence in long-term interest rates between the two countries indicates a loss of bearings regarding French challenges.
Will the budget be passed?
The key question concerns the government’s ability to put the economy and the budget on a path toward balance. The budget just presented lacks conviction; it will likely not be passed by the National Assembly due to a lack of a majority, and even if it is, it will be challenged by the government elected after the election. Why ally with a minority government when a party is fielding its own candidate?
Who would find it advantageous to support the prime minister just a few months before the elections?
Therefore, holding French debt becomes a gamble with no visible limit; each rate hike devalues portfolios, and there’s no telling where the downward spiral will end. It’s a position that’s difficult to justify in the long term. For them, other opportunities exist in a debt market that has become very large with a more balanced distribution of risk.
The ECB, a lifeline with conditions
An intervention by the ECB is complex. Its anti-fragmentation instrument, the TPI, is reserved for unjustified market tensions, disconnected from fundamentals. However, the French problem is primarily budgetary.
Any further intervention by the central bank would require a commitment from Paris regarding its fiscal strategy. But can a government without a majority, slated to be replaced in May, commit the country to a long-term course? And with what legitimacy, when each candidate, standing on their high horse, promises that with them, everything will be sorted out?
Especially since the pill they swallowed would be very bitter. Let’s remember Spain, Portugal, and a few other countries during the sovereign debt crisis! The size of the public sector was drastically reduced, pensions were cut, and wages were severely eroded.
The crisis could worsen in two ways.
The first reason is the lack of attractiveness of debt for investors, particularly during issuances by the French Treasury. The amounts raised are insufficient because prices are too low (and interest rates too high). Consequently, this phenomenon can become cumulative, creating distrust and generating a genuine financing crisis for the French state. Drastic budgetary adjustments would then be necessary for a government still without a majority.
The second point is that this French crisis is prompting non-European investors to turn away from European debt. The euro’s decline may be an initial sign of this. This could fuel imported inflation and drive up energy prices, thus constraining the ECB’s monetary policy strategy. The French crisis would then increase the risk of fragmentation within the eurozone. This may have already begun in high-risk countries. For countries adhering to the rules, the ECB could implement the emergency intervention procedure. France would then face significantly greater pressure to adjust.
Two scenarios plus one
For reasons beyond our control, the Strait of Hormuz becomes less congested, capital risks diminish, inflationary pressures dissipate, and interest rates fall worldwide. Specific expectations disappear, and the situation normalizes. The focus on France would then fade.
The other possibility concerns the eight months leading up to the elections. Can France endure eight months with these escalating tensions? Will it be able to weather the storm by offering concessions that don’t resolve everything but allow it to wait for the next president, or could a political crisis trigger a sudden shift, forcing a premature election ?
