French Markets Tumble Amid Protests and Political Crisis

French bonds, Paris-listed stocks and the euro fell on Monday after widespread protests across France underscored the government's difficulties in reducing France's large deficit. France, the euro zone's second-biggest economy, already faces weak growth and ballooning debt. France experienced some of the country's worst unrest in years over the weekend. Thousands of people were arrested and shops were looted during protests over high prices and declining public services. France's central government asked some local authorities to impose curfews on Monday. Prime Minister Sebastien Lecornu did not rule out declaring a state of emergency.

Falling bond prices pushed France's 10-year yield up 13 basis points to 4.9% on Monday, on track for the largest one-day rise since late September. Germany's 10-year yield, the euro zone benchmark, rose 4 basis points to 3.45%. The gap between French and German yields reached 146 basis points, the highest in two weeks. The gap reflects the premium investors demand to lend to France rather than Germany. However, the gap remained below the nearly 160 basis points reached in early October. France's 10-year yield reached 4.99% in early October, the highest since 2002, and yields are now moving back toward that level.

Investors say France needs to pass a budget bill to rein in public finances, but the protests demonstrate how difficult passage could be. Political competition ahead of next year's presidential election could further complicate matters. SMBC global market strategist Hank Calenti said the protests showed declining hopes for deficit reduction and pension reform. Calenti said the impact extended across the euro zone as reforms investors hoped for in several markets looked less likely. Calenti noted that German yields rose on Monday while US yields fell. Investors fear rising French yields could spread to other heavily indebted euro zone markets and see Italy as the first market to watch. Italy's 10-year yield rose 11 basis points to 4.58% on Monday. Recent moves in French debt also illustrate how hedge funds' growing role is making the market more vulnerable, a risk regulators are watching closely.

French stocks performed worst among major European stock markets. The blue-chip CAC 40 index fell 1.5%, compared with a 1% decline in broad European stocks. Shares in BNP Paribas and Societe Generale, two of France's biggest lenders, each fell 3%. French banks tend to underperform when the gap between French and German bond yields increases. French retailers also faced pressure, with Carrefour shares falling 1.8%. Carrefour's CEO said Carrefour's losses from protest damage would reach tens of millions of euros.

The cost of insuring French sovereign debt against an increase in default risk rose. France's credit default swap rose 5 basis points from Friday's close to around 82 basis points, the worst performance on the day. However, the credit default swap remained below the October 2 high of 89 basis points. Moody's will review France's credit rating on Friday, potentially resulting in a downgrade that could add pressure on French bonds. However, Commerzbank analysts said any widening of yield spreads following a downgrade would likely remain limited because Moody's was merely following other rating agencies.

Developments in France also weighed on the euro. The euro fell 0.2% to 0.3% against the dollar, pound and yen on Monday.