The French risk and the bond market - 22 june 2026
With less than a year to go before the elections, investors are treating the French question as a local issue rather than a European one. They are no doubt partly right, but the alternatives to OATs may now lie outside the euro area.
Since the dissolution of the National Assembly in June 2024, French political instability has kept the risk premium on 10 year OATs at around 70 basis points above Germany, compared with 50 basis points previously. The punishment may appear modest, but it is in fact substantial, because at the same time the risk premiums of other euro area countries have fallen significantly – on average (unweighted) from 70 basis points to 40 basis points today (Chart 1).
The difference in trend between France and the rest of the euro area shows that, so far, investors have treated the French question as a local risk, without any notable impact on the management of the euro area, despite the country’s economic weight (18% of euro area GDP) and its even greater political weight within the bloc. This is a strong signal, indicating solid market confidence in the integrity and durability of the euro area, despite an ECB that is clearly less accommodative than it was over 2015–2021. Successive crises weathered, the rehabilitation of Southern European economies, the strength of the banks and the ECB’s anti fragmentation backstop have built that confidence.
The Italian precedents of 2018 (Salvini–Di Maio) and 2022 (Meloni) suggest that even a major political shift in a systemically important country is not enough to destabilise the euro area. The most fraught episode was in 2018 (Chart 2), when, unexpectedly, two populist parties – the Northern League and the Five Star Movement – formed a coalition hostile to Europe and to fiscal discipline. The Italian spread more than doubled, but that of other euro area countries held up fairly well. In 2022, the resignation of Mario Draghi and then the election of Giorgia Meloni also caused a few jitters, but the new prime minister quickly adopted a conciliatory stance.
This is the kind of scenario most investors have in mind for next year. If, in 2027, France was to elect a president and an assembly hostile to “Brussels’ diktats”, the result would be increased market pressure on French debt, rather than any fundamental questioning of the rules of the single currency (1). This pressure would push the new government to offer assurances of fiscal seriousness within a more or less short timeframe.
However, this diagnosis and scenario call for two important comments:
• First, the state of French public finances and the political risk in 2027 are already having a negative impact on the euro area. They provide an ideal pretext for the German government to postpone eurobond projects, which have recently been revived by many economists and policymakers. This is a missed opportunity to strengthen Europe, consolidate the single currency and improve its resilience to crises, even if other financial union projects continue to move forward.
• Second, the indifference of bond markets in the rest of the euro area to the French situation is relative. Already very low, yield differentials with Germany may find it difficult to compress further and could even widen temporarily as the French elections approach.
In terms of strategy, it therefore seems preferable to us to look for alternatives to OATs outside the euro area. Among the possible options, two other risky sovereign assets – heavily buffeted in recent years – have attracted our attention: UK and Japanese government bonds.
At close to 5% on the 10 year, UK gilts carry both inflation risk and political fiscal risk. However, UK inflation is slowing, and the fiscal risk is limited by the “Liz Truss” episode of September 2022 (2). Even Andy Burnham, a very left wing Labour figure now tipped to replace the current prime minister Keir Starmer, has already committed to maintaining the deficit reduction path set by the current government.
In Japan, the risk premium on long and very long term rates has risen significantly in recent months. Long term inflation expectations on the markets are now above 2%, and the yen is under pressure despite the recent rate hikes by the Bank of Japan – largely because the ECB and the Fed are turning more hawkish at the same time. Liquidity problems have also emerged in the bond market in 2025–2026, but these are in the process of easing. At 2.65% on the 10 year, Japanese yields are approaching German yields and even exceed them on longer maturities (15–30 years), at close to 4%, while Japanese inflation has fallen back below 2% in recent months.
At current yields, a 50/50 portfolio of Japanese and UK government bonds now offers a return higher than long term French yields (Chart 3). This portfolio could benefit from easing inflationary pressures driven by falling energy prices, whereas OATs are suffering from issues that seem difficult to resolve before the 2027 elections, despite an attractive risk premium compared with other euro area issuers. Another, very similar, option with a better yield is to replace the 10 year Japanese bond with a 20 or 30 year bond, adjusting the invested amounts to consider the difference in duration.
- Conversely, the election of a president aligned with European orthodoxy would no doubt trigger a significant narrowing of the OAT–Bund spread.
- Following the presentation of a tax cut programme by Prime Minister Liz Truss, long term UK interest rates soared. This market episode was probably due more to financial disruption linked to pension fund management than to any real public debt problem, but its imprint is strong. The Bank of England intervened, and Liz Truss resigned shortly afterwards.
