Analyst tells Oninvest how to tell if France’s debt crisis is spreading

France’s debt crisis is putting pressure on banks and the euro, but it has yet to develop into a systemic problem for the euro zone. What should investors watch next?

“The global rise in long-term yields has hit the weakest links, including France,” Frederik Ducrozet, head of strategy and macroeconomic research at Pictet Wealth Management, told Oninvest. French government bonds have undergone a “brutal selloff” in recent weeks, the Financial Times notes. The yield on 10-year sovereign debt has approached 5%, its highest level in almost a quarter century. French sovereigns have been the worst performers among those of any Group of 10 country since the start of the year, writes Bloomberg.

The yield spread between French and German 10-year sovereigns, a key gauge of the market’s perception of risk, has widened sharply over a short period and approached levels seen during the eurozone debt crisis. In early October, the gap stood at 1.59 percentage points. The selloff in French bonds has also weakened the euro. On Tuesday, the single currency fell to its weakest level since May 2025 as investors worried that the French market turmoil would spread to other countries.

The selloff in French debt was triggered by a combination of factors. For one, protests by high school students and public-sector workers opposed to spending cuts are continuing in France.

Meanwhile, French Prime Minister Sébastien Lecornu presented a draft 2027 budget in early October that includes measures to reduce the budget deficit, among them limits on pension indexation and a partial freeze on civil servant salaries. France’s national debt is EUR3.5 trillion, or almost 120% of GDP, well above the eurozone average. Debt-servicing costs have become the country’s largest budget expenditure, surpassing spending on education and defense.

Yet the draft budget faces fierce opposition from lawmakers, potentially threatening to topple the government. The upcoming presidential election represents another source of uncertainty. Polls show that a second-round contest could pit far-right scion Marine Le Pen against far-left firebrand Jean-Luc Mélenchon.

“The catalysts for the sharp selloff are not entirely clear. France’s problems are not new: growth is underperforming, fiscal dynamics are deteriorating, and political fragmentation is limiting the scope for corrective action, let alone structural reforms," Ducrozet says. "On the other hand, there have been some idiosyncratic drivers of the widening in French sovereign spreads, including difficult budget discussions, shifting opinion polls, and more radical policy proposals from populist parties."

Deutsche Bank analysts broadly agree: the government's budget announcement was in line with expectations, while broader political signals from both centrists and the French right continue to indicate recognition of the need for significant spending cuts, they noted in an October 2 note.

The widening yield spread between French and German government bonds has also reduced the appeal of French stocks, Bloomberg notes. Financial stocks have been hit particularly hard. AlphaValue noted in an October 5 note that Crédit Agricole shares had lost about 18% since mid-August, while Société Générale is off 24% from its previous high. Stocks of firms focused primarily on the domestic market, particularly those in the infrastructure and real estate sectors, have also declined.

However, according to JPMorgan, the widening spread between French and German sovereigns has so far had only a very limited impact on banks. Even a 100-basis-point widening would reduce their common equity Tier 1 (CET1) ratios by less than 4 basis points. The recent selloff reduced the ratios of BNP Paribas and Crédit Agricole by about 4 basis points and Société Générale’s by around 1 basis point.

JPMorgan attributes the limited impact to the diversification of the banks’ sovereign-bond portfolios, hedging of interest-rate risk, and the fact that a significant portion of their bonds is carried at amortized cost. France generates about a quarter of BNP Paribas’ revenue, 40% of Société Générale’s, and almost half of Crédit Agricole’s. The country also accounts for 30%, 40%, and 58% of their respective loan portfolios.

JPMorgan expects government bond yields to rise further and spreads over German bonds to widen, tightening financial conditions for companies and households. This could also reduce French banks’ earnings: every 10-basis-point increase in the cost of risk, or loan loss provisions, would lower their 2027 earnings by 1-2%.

Ducrozet expects the resulting uncertainty to persist. “The most likely outcome is a prolonged period of political bargaining, partial fiscal measures, and a structurally higher risk premium,” he believes.

To determine whether the turmoil is spreading beyond France, Ducrozet recommends monitoring other parts of the European bond market as well. “We’re watching French spreads and French sovereign auctions for liquidity risks, but also Italian spreads including at shorter maturities for signs of contagion,” he shared.

In an October 2 note, Deutsche Bank pointed out that the European Central Bank has at its disposal the Transmission Protection Instrument, or TPI, to shield the euro zone from sharp, unwarranted market moves. However, it remains unclear when the regulator would decide to intervene and which countries’ markets it would support. Deutsche Bank reckons that France could theoretically meet the conditions for the TPI to be deployed. The mechanism includes oversight of fiscal discipline and, for France, would require its budgets to be approved by the European Commission.