Lecornu's month-end deadline leaves French bondholders carrying the risk of spending concessions

Until the end of the month, French bondholders are holding the outcome of a decision the government has not yet made ^[1]. There are three ways it can go. Lecornu can give the protesters money, in the form of the "expensive concessions" that Macquarie's Thierry Wizman and Gareth Berry wrote become harder to justify as yields rise ^[4]. He can hold to restraint, which is what bondholders want with public debt at 120% of GDP ^[2][3]. Or he can offer something in between and leave the real budget fight to the spring presidential election ^[5].

The market has already picked one of these. More precisely, it has priced the second. Gavekal's Cedric Gemehl said spreads currently assume France hits its 2026 budget target, gets some consolidation into next year's budget, and comes out of the election without a significant weakening of its public finances ^[12]. "If these assumptions hold, they could provide an anchor for French spreads around the current levels," he wrote ^[13]. Two of the three, the 2026 target and next year's consolidation, depend on the spending restraint the protesters want dropped ^[17]. "But there is a large probability that one or more of these assumptions will prove wrong, which would lead to a further widening in French spreads," Gemehl wrote ^[14]. The report does not give a current spread or yield level.

The loop Macquarie describes has happened before. Between 2010 and 2013, rising sovereign yields in Greece, Italy and Spain damaged the banks that held the debt. Savers moved money to Germany and the Netherlands. The European Central Bank responded with bond purchases and, together with the Federal Reserve, currency swap lines ^[7]. Macquarie saw no deposit flight from France through August 2026, and the strategists said a run on deposits would be the first sign the ECB could step in directly with liquidity ^[6]. Matt Eagan of Loomis Sayles said French banks have held up reasonably well but will likely feel the heat as the crisis unfolds ^[16].

The debt office has already changed course. "France mentioned they are thinking of increasing issuance of shorter-maturity debt, which suggests they know that it might be more difficult to build a book of demand for longer-dated issues at a reasonable price," Eagan said ^[9]. If Eagan is right, the Treasury is not testing the long end at the price buyers would now demand. He said the "yellow lights are flashing" but that Europe is not yet in a crisis, and that France, almost too big to fail, is less exposed than Greece was ^[8]. He also thinks it is too early for the ECB to help France directly ^[10].

I think the weeks before Lecornu speaks carry more risk than current spreads allow for. The priced outcome needs restraint from a government facing street protests and an election ^[17][5]. Gemehl makes the opposite case. He sees no repeat of the euro crisis, expects Europe to provide a backstop, and calls Italy's turmoil after it elected a populist government in 2018 the better parallel ^[15]. That backstop comes with conditions. "I don't think the rest of the euro members would step in directly to help France without concessions from those governing the country, which is uncertain at this point until elections are held," Eagan said ^[11]. This view would be wrong if the month-end package keeps next year's consolidation intact, spreads hold near current levels and French deposits stay where they are ^[12][6].