Amid a confluence of fiscal deterioration and political gridlock, investors have driven French government bond yields to their highest level in nearly two decades, placing the eurozone's second-largest economy under intensifying scrutiny.

The benchmark 10-year French bond yield reached a peak not witnessed since 2008 last week, before hovering near the 4.1% mark on Friday. This surge in borrowing costs comes as France prepares for another arduous budget battle, with its public finances showing persistent signs of strain and repeated breaches of EU fiscal rules.

Political instability has been a defining feature of France's recent landscape. Multiple administrations have attempted reforms, spending cuts, and tax increases to reverse the trend, only to see their efforts fail and their governments collapse. Consequently, France remains under the EU's excessive deficit procedure, which mandated fiscal correction by 2029, yet the country remains far from achieving its targets.

The EU's reference standards set a 3% of GDP limit for government deficits and a 60% ceiling for public debt. However, France's deficit stood at 5.1% of GDP last year, with debt exceeding 115%. The International Monetary Fund's July projections paint a challenging picture, forecasting total government debt to rise to approximately 118.5% of GDP in 2026, surpass 120% in 2027, and remain above that threshold through 2030.

Meanwhile, economic growth remains tepid, with GDP contracting by 0.2% quarter-on-quarter in the first quarter and stagnating in the second. This weak performance, combined with the volatile political climate, has heaped significant pressure on French bonds. Over the past year, yields have climbed steadily, amplified by global factors such as geopolitical tensions, making France one of the G7 nations with the highest government borrowing costs.

The deeply divided National Assembly has seen frequent no-confidence votes and successive government collapses, repeatedly throwing the national budget into deadlock. France must submit its 2027 budget draft to parliament in early October. Last year's budget negotiations stalled for months before Prime Minister Sebastien Lecornu used special powers to force the legislation through. Lecornu, who took office in 2025 as France's fifth prime minister in two years, resigned just 27 days into his tenure due to irreconcilable political divisions, only to be reappointed by President Emmanuel Macron days later.

Adding another layer of uncertainty is the 2027 presidential election, where far-right candidate Marine Le Pen currently leads in polls, positioning herself as a potential successor to Emmanuel Macron.

France as a "Textbook Example" of Debt Risk

John Stopped, head of multi-asset income at asset manager Ninety One, highlighted that while ballooning deficits and slowing growth are global challenges following the pandemic, wars, and energy crises, France's situation stands out. "It's not just a French problem, but in many ways, France is the poster child for this type of risk. The issues aren't unique, yet France's public finances have been consistently deteriorating," he said. Stopped noted that developed economies broadly face the challenge of balancing budgets and putting debt on a sustainable path, warning that failure to do so could trigger a "bond market revolt." He expressed understanding of market concerns regarding France, stating, "It's hard to see a happy ending at the moment."

The biggest variable for the French bond (OAT) market, according to Stopped, is next year's presidential election. In a Thursday debate, Le Pen stated the government "must cut spending drastically," while expressing deep concern about France's debt trajectory. However, Stopped suggested markets are skeptical about Le Pen's genuine commitment to significant fiscal consolidation. "After May next year, there could clearly be a change in government or policy focus, but markets doubt whether there is a real will to implement sufficiently forceful austerity. So, a crisis might be brewing, just not necessarily one that erupts immediately."

Few Signs of Improvement

Theophile Legrand, a rates strategist at Natixis CIB, described French bonds as being in a "state of stressed alert." He explained that the broader macroeconomic environment, not just domestic politics, is hindering improvement. "Markets don't expect France to bring its deficit under 3% by 2027, but they do expect the 2027 budget to provide a credible medium-term path that can stabilize public debt. And achieving that path is becoming increasingly difficult. External factors like the war situation and higher long-term interest rates have worsened the fiscal picture, and this summer's heatwaves and wildfires have added another layer of uncertainty."

Legrand also noted that with budget debates deeply intertwined with electoral politics, French bonds are most likely to see renewed volatility in the final months of 2026 and into the first quarter of 2027. "Even so, we don't expect a repeat of the 2024-2025 shock. French bonds are already significantly stressed: our fair value model suggests the 10-year OAT is undervalued by around 15 basis points relative to its fundamental value, excluding political risk premium. We estimate the year-end OAT-Bund spread at around 75 basis points if the budget passes smoothly, and potentially 80 basis points if the budget fails and France resorts to special budget legislation."

April Larousse, director of investment specialists at Insight Investment, observed that despite the growing negative narrative around the French economy, there are "almost no signs" of the fiscal adjustment necessary to address the debt situation. "Growth expectations keep being downgraded, debt keeps rising, and bond yields are back to levels not seen since the financial crisis. But for political reasons, large-scale spending cuts are very difficult. Pension reform is effectively shelved until after the 2027 election, parliamentary factions are highly fragmented, and the government prioritizes maintaining political stability over tackling deep-seated fiscal problems."

She pointed to the core question for investors: whether policymakers can summon the political will to put public finances back on a sustainable path before market pressures intensify. "French bonds now trade cheaper than Italian ones, which was unimaginable in the past. But if the negative scenario materializes, French bond prices could weaken further."