Budget Crisis Overlaps with Approaching Election! Political Risk Premium Continues to Rise as French Government Bonds Face Short Sellers

According to Zhitong Finance APP, as French politicians prepare for an intense battle over the 2027 budget, and with the presidential election drawing nearer, investors are turning bearish on French government bonds. Bond futures trading data show that investors are building new short positions on French government bonds—the number of open interest contracts for the French 10-year government bond futures maturing next year has surged to the highest level since early June. Since early June, this contract has remained the most actively traded French treasury futures contract.

According to a team of Barclays strategists led by Mark Kittson, the market's bearish bets on French government bonds seem to have been increasing throughout the summer. In a report on August 12, the strategists wrote that investors are "seeking to position themselves ahead of upcoming domestic political catalysts," with the "most notable being this fall's budget process and next April’s presidential election."

Carmignac Gestion's fixed income fund manager Marie-Anne Allier pointed out: “We are heading into an election, and there is likely to be significant political instability leading up to 2027. It’s a dynamic that is particularly unfavorable for France.” She is currently shorting medium-term French government bonds while going long on German, Italian, and Spanish government bonds.

As the autumn budget approaches, traders are shorting French government bonds

Starting in September, French Prime Minister Sébastien Lecornu will have to deal with a divided parliament while his government is drafting the 2027 budget with the aim of reducing the fiscal deficit ratio to below 5%. He has warned that if no agreement can be reached, passing the fiscal plan could be delayed until very late next year, possibly resulting in the deficit ratio rising to 6.5%. Meanwhile, various candidates are also positioning themselves for next year's presidential election. The election will consist of two rounds, scheduled for April 18 and May 2, 2027.

Polls show that far-right populist politician Marine Le Pen is currently leading in next year’s presidential race. Le Pen’s increasing support could make it more difficult for Lecornu’s government to push through fiscal tightening measures. On the far-left, candidate Jean-Luc Mélenchon has proposed increasing spending and canceling part of the national debt held by the French central bank.

On Friday, the yield on France’s 30-year government bonds soared 12 basis points and rose again slightly on Monday to 4.86%, marking its highest level since 2008. The yield premium demanded by investors for holding French 10-year bonds over German bonds jumped to 84 basis points last Friday, the highest since October last year, indicating that pressure is mounting on French government debt.

French political risk premium widens yield spread with German bonds

Natixis interest rate strategist Théophile Legrand stated that his index for measuring country-specific risk shows that about 25 basis points of the French-German bond yield spread can be attributed to such risks, “the highest level since tensions related to the December 2025 budget.”

There are already some clues as to what might be included in the next budget. In an interview in July, Lecornu stated he did not wish to raise taxes. At the same time, losses caused by wildfires, heatwaves, and droughts that swept across France this summer are becoming an additional pressure on public finances. In a letter to farmers over the weekend, Lecornu promised to introduce new measures by 2027 to support those affected by these disasters.

Last month, French Finance Minister Roland Lescure revised the government's 2026 economic growth forecast down from 0.9% to 0.7%, and said that achieving the target of reducing the fiscal deficit ratio from 5.1% in 2025 to 5% now looks “extremely challenging.”

Mediolanum portfolio manager Neil Scanlon stated that before he begins buying French government bonds, he would like to see the yield spread between French and German 10-year bonds widen further. Scanlon said: “If the spread approaches the upper limit of 90 basis points, we may start to buy small amounts of French government bonds, overweighting them relative to German bonds at that level.”

This autumn, France’s credit rating will also come under close scrutiny again, possibly leading to further bond market volatility. Last autumn, due to the challenges faced by the minority government in passing the budget, S&P Global Ratings, Morningstar DBRS, and Fitch Ratings all downgraded France's debt rating. Moody’s also lowered its outlook for France’s rating. France’s Debt Management Agency expects credit rating decisions from these agencies will begin to be announced from August 28, with further assessments continuing until the end of the year.