France’s CDS has decided to say goodbye to everyone and head higher

French Credit Default Swaps, basically the cost of insuring against a default on the country’s sovereign debt, have climbed to around 84 basis points.

At the same time, the French 10-year government bond yield is moving close to 5%, one of the highest levels in the Euro Area.

France is increasingly starting to look like the new sick man of Europe.

The latest move came after Prime Minister Sébastien Lecornu presented the 2027 budget.

The objective is to bring the deficit back to around 5% of GDP, after 5.1% in 2025 and an estimated 5.4% in 2026.

Without intervention, the deficit could rise to around 6.5%, mainly because of higher interest costs, pensions and other public spending.

The government is therefore proposing a fiscal adjustment worth roughly €54 billion.

And who is going to pay for it?

Mostly taxpayers.

The tax burden is expected to rise from 43.9% to 44.2% of GDP. Some benefits for pensioners would be reduced, tax exemptions would be cut, the government would tighten its fight against tax fraud and the additional levy on large corporations would remain in place.

On the spending side, public-sector wages, housing subsidies and family benefits would be frozen.

Higher pensions would also no longer be fully indexed to inflation.

But the number that really matters is the cost of servicing the debt.

Interest expenditure is expected to rise by another €12 billion, reaching around €91 billion.

That increase alone is significantly larger than the planned €6.4 billion increase in defence spending.

And even if the budget is approved in full, French debt would still continue to rise.

Debt-to-GDP is expected to move from around 119% in mid-2026 to roughly 121.7% in 2027.

That is the real issue.

A 5% deficit is not enough to stabilise the debt trajectory, and markets have clearly started to understand that.

Then There Is Politics

The fiscal situation is only half of the story.

Macron’s government does not have a stable parliamentary majority, which makes passing such an unpopular budget extremely difficult.

The most likely outcome is probably several more weeks of negotiations, possibly until the end of November, before the government eventually tries to pass the budget through Article 49.3 of the French Constitution.

That would allow the government to approve the budget without a parliamentary vote.

The problem is that it would also expose the government to a no-confidence motion.

And this is probably the biggest risk for French assets right now.

If the government falls, political uncertainty would rise sharply.

Markets would immediately start focusing on the possibility of Marine Le Pen’s Rassemblement National or Jean-Luc Mélenchon’s La France Insoumise gaining even more political influence.

From a market perspective, both scenarios would create additional uncertainty around France’s fiscal path and could push borrowing costs even higher.

That said, a no-confidence vote is not necessarily the most rational choice for the opposition.

Why bring down the government now?

The current government is the one being forced to implement an extremely unpopular fiscal adjustment.

It may actually make more sense for the opposition to let Macron’s administration absorb the political cost of the austerity measures and then try to benefit from the backlash during the 2027 presidential election.

In other words, why take responsibility for the problem today if you can let someone else take the blame and potentially win the election afterwards?

France Is Not Greece, But That Does Not Mean Everything Is Fine

The Banque de France has also started to sound increasingly concerned.

The message is fairly simple.

France is not Greece, but if interest costs continue to rise, they could gradually squeeze the country’s public finances.

That naturally brings the ECB into the discussion.

The problem is that France cannot simply assume that the ECB will step in immediately.

The ECB has its Transmission Protection Instrument, the TPI, which is basically its anti-fragmentation tool designed to prevent disorderly moves in sovereign bond markets.

But the TPI is not unconditional.

A country benefiting from ECB support is still expected to follow a credible fiscal path and broadly respect the European fiscal framework.

And this is where France has a problem.

Its deficit is still far above the traditional 3% European threshold and investors are questioning whether the government can realistically implement a credible adjustment plan.

That means the ECB cannot simply provide an unconditional backstop to French bonds.

And the lack of an obvious safety net is one of the reasons why investors are increasingly willing to demand a higher risk premium on French debt.

The CAC 40 Is Telling the Same Story

The equity market is starting to reflect the same concerns.

The CAC 40 has been struggling, particularly since August, and is down roughly 4% year-to-date compared with a gain of around 6% for the STOXX Europe 600.

The question is what happens from here.

My view is that the ECB would eventually step in if French sovereign stress became a broader Euro Area problem.

But probably not yet.

As long as the stress remains mostly concentrated in France, it is difficult to justify a major intervention.

The situation becomes different if the pressure starts spreading to other countries.

Italy would obviously be one of the first markets to watch.

If French political instability started to push Italian spreads higher as well, the ECB would have a much stronger argument for intervening.

That is probably also the point at which French equities could finally start to recover.

We Have Seen Something Similar Before

There is an obvious parallel with Italy in 2022.

After Russia invaded Ukraine and European energy prices exploded, the Italian BTP-Bund spread widened by more than 100 basis points in roughly six months, reaching around 238 basis points.

During the same period, the FTSE MIB fell by roughly 22%.

Then the ECB announced the TPI.

Interestingly, the instrument was never actually used.

It did not need to be.

The simple fact that the ECB had created a credible tool to limit excessive fragmentation was enough to improve investor confidence.

Of course, other factors also helped.

European gas prices started falling, Giorgia Meloni formed a government with a strong parliamentary majority and the ECB started raising interest rates, which was particularly positive for the large Italian banks.

Over the following six months, the FTSE MIB gained around 22%.

And that is probably the most interesting lesson from that episode.

The ECB does not always need to intervene.

Sometimes markets simply need to believe that it can and will intervene if necessary.

France may now be moving towards a similar situation.

The difference is that the ECB probably needs to see more stress before stepping in.

So before things get better, they may have to get worse first.