French Political Unrest Drives Down Stocks, Bonds, and Euro Amid Rising Borrowing Costs

French government bonds, Paris-listed stocks and the euro fell early on Monday amid social unrest, political instability and mounting national debt. The euro was last down 0.15% against the U.S. dollar. The euro was 0.13% lower against the British pound. France's 10-year government bond yield rose 7 basis points, remaining near the highest level in decades despite some recent easing. France's 2-year government bond yield rose 2 basis points. France's 30-year government bond yield rose 6 basis points. Higher government bond yields represent higher government borrowing costs.

The CAC 40 fell nearly 1% in early trading on Monday. The index has significantly underperformed European peers in recent years, despite generating only around 15% of revenues domestically. Banks have faced particular pressure. France's stock market is historically sensitive to widening in the OAT-Bund spread, the additional yield France pays over Germany. The spread remained near levels last seen during the euro-area debt crisis after reaching the highest level since the early 2010s. Widening spreads raise concerns about corporate financing costs and heighten fears of higher taxes and tighter regulation.

Goldman Sachs senior European equity strategist Sharon Bell said a broader downturn in high-end consumer spending in China was further harming France's luxury companies. Bell said the latest turmoil affected investors' perception of risk in French assets.

Hundreds of thousands of people marched over the weekend against political paralysis, the cost of living and the condition of public services, including schools and healthcare. Mass gatherings in cities including Paris, Lyon and Marseille involved buildings and cars being set on fire, clashes with police and more than 2,000 arrests. Deutsche Bank analysts said on Monday that the escalation would make international investors less comfortable buying French government bonds. Investors had already pushed France's benchmark borrowing costs to the highest level since 2002 by demanding a higher premium to fund government spending.

Investors face uncertainty over next year's presidential election, with far-right Marine Le Pen leading many polls. Investors are also focused on whether Prime Minister Sébastien Lecornu's minority government can pass the 2027 budget, currently under negotiation. Investors want a credible path to reduce France's deficit. Increasingly difficult budget negotiations have toppled two of Lecornu's recent predecessors. Analysts say lenders are demanding a strong fiscal consolidation program to avert a debt crisis. France's persistently high deficit-to-GDP ratio and weak economic growth continue to pressure government borrowing costs.

Bell said reducing the budget deficit would be difficult without painful measures. Bell said taxes could rise for French businesses and might rise more generally in France. Bell said fiscal consolidation requires either lower spending or higher taxes, both of which are difficult. Bell said Le Pen had discussed maintaining a golden budget rule during a presidential term but had not detailed how the rule would work. Bell said investors' skepticism about fiscal consolidation and a declining deficit was one reason OAT-Bund spreads were not narrowing.

Bell said current conditions did not warrant emergency intervention by the European Central Bank. Bell said the ECB did not want to use tools such as the Transmission Protection Instrument. However, Bell said the ECB would use the mechanism if spreads began disrupting market liquidity. Bell said intervention would be politically sensitive and would likely require France to undertake even stricter fiscal reforms over a long period. Bell compared those potential requirements with reforms in Greece and Ireland during the sovereign debt crisis. Bell said market pressure was sometimes necessary and had been evident this year.