Northern Trust believes that France's fiscal imbalances have spread from the sovereign debt market to the banking credit market. Because French banks hold a large amount of French government bonds, pressure in the sovereign bond market is affecting the pricing of bank funding risks.
Market data comprehensively reflects France's credit pressure: the yield on 10-year French government bonds rose 67 basis points in September; the spread between French and German government bond yields more than doubled; the spread of French bank credit default swaps (CDS) has increased by more than 50% in the past six months; France's fiscal deficit is projected to be 5.5% of GDP in 2024, and the draft budget for 2027 proposes to reduce the deficit to 5.0%, still higher than the EU's 3% standard.
France's sovereign credit risk is being transmitted to financial institutions, mainly due to its persistently poor economic performance. This is a typical microcosm of many problems hindering Europe's competitiveness: a lack of economic dynamism, a lack of capital to support entrepreneurship or productive investment, and stringent labor protection measures restricting the movement of people.
These problems are long-standing, but every attempt at reform has invariably encountered protests. Ultimately, maintaining the fiscal imbalance has become the option of "least resistance."
However, significant divergence remains within the European bond market: France is clearly under pressure, while Italy remains relatively calm. Northern Trust believes the European Central Bank will likely only consider using its Transmission Protection Instrument (TPI) to purchase bonds if the pressure in the French market spreads to other Eurozone countries. This means France will need to rely on fiscal adjustments to stabilize its bond market.
