France has been engulfed by turmoil, with students out on the streets to protest cuts at schools. Investors are rebelling against the government, too, by questioning the country’s ability to manage its huge debt pile.
France has emerged as the European epicenter of global turmoil in bond markets and serves as a warning to politicians around the world contending with higher borrowing costs. It’s a perilous financial backdrop to the protests. On Thursday, for the second time in a week, high school students and their supporters came out across France, calling for more teachers and the renovation of dilapidated school buildings.
Rising interest rates expose the vulnerability of countries with high debt burdens and stubborn deficits. When governments must spend more on debt payments, it leaves less money for other priorities like improving schools, building more housing or cutting taxes — and that can push frustrated voters into the streets or into the arms of populist political parties.
“These bond yield rises have very real implications,” said Mahmood Pradhan, a nonresident fellow at Bruegel, a think tank in Brussels, and former deputy director of the European department at the International Monetary Fund.
In a nightmare scenario, the dynamics become a self-fulfilling spiral: Politicians make more promises to appease aggrieved citizens, leading to more borrowing and, in turn, spooking investors, who demand even higher rates to keep buying government bonds.
France shows how quickly the situation can escalate when investor sentiment turns sour.
This week, the yield on 10-year French bonds nearly touched 5 percent, the highest since 2002. More worrying, another measure of investors’ feelings toward French debt has attracted fresh attention: the so-called spread between 10-year yields on French and German government debt. The gap shows the premium traders are demanding to hold French debt over the alternative from Germany, which is considered the safest borrower in Europe.
This spread recently reached the widest since 2012 after an astonishingly rapid increase this past month. Investors have also demanded higher returns to lend to France than to Italy and Greece, which were long considered Europe’s most problematic high-debt nations.
Across Europe, rising bond yields are testing the resilience of economies. The year started with low inflation and faster economic growth. But since the war in Iran began, energy prices have soared, pushing inflation back up and prompting the European Central Bank to raise interest rates twice this year. Traders expect another rate increase by the end of the year.
The rise in borrowing costs leaves governments exposed to new economic shocks like sudden increases in food and energy prices. It will give them less leeway to support businesses and households, in ways they have in recent years. “The limited ability of countries to deal with these shocks is a new world for us,” Mr. Pradhan said.
In France, interest payments are one of the biggest expenses in the government’s budget, and could eat up more than 90 billion euros ($100 billion) next year, more than planned spending on defense and education, according to the French finance ministry. Emmanuel Moulin, the governor of the French central bank, recently told The Financial Times that the country was at risk of being “strangled by interest rates” if it doesn’t improve its public finances.
France’s incumbent political leaders — and some hopeful contenders — are scrambling to reassure skeptical investors. But so far, their overtures are having limited impact. The government said last week that it would aim to shrink its budget deficit next year, after failing to do so this year. But even then, debt levels will keep rising. France’s government debt is already nearly 120 percent of the size of the economy.
Investors have been tracking budget negotiations in Paris closely, but they expect that France’s fiscal problems could be intensified by presidential election next spring. So far all the leading candidates have all made big spending promises and not presented convincing plans to reduce debt. Marine Le Pen, the far-right front-runner, this week vowed to cut the deficit but didn’t detail how, while Jean-Luc Mélenchon, the far-left candidate, has alarmed investors by proposing to cancel some of the country’s debt instead of repaying it.
France might get “some temporary relief in markets if they can get some measures passed in parliament,” Mr. Pradhan said. “But beyond that, France has a debt problem.” The country has large spending needs that have been politically difficult to restrain, in areas such as pensions, which are compounded by rising interest payments.
These are issues shared elsewhere. In some ways, the United States is at the core of the market tumult. In recent months the yields on U.S. Treasuries, the largest and most influential bond market in the world, have jumped and triggered a global sell-off.
The United States still enjoys plentiful demand for its debt and one important factor driving up yields is Silicon Valley’s artificial intelligence boom. But economists warn that the country is continuing to push the frontier of what investors might accept from governments if they are seen as unwilling or unready to tackle rising debt levels. America’s gross national debt topped $40 trillion this summer, or more than 120 percent of the size of the economy, while annual deficits are set to keep expanding.
In Asia, Japan’s debt trajectory recently tested the nerve of the market. Japan’s debt has been more than twice the size of the its economy for many years, but recent government promises to increase spending and cut taxes has punished Japan’s financial assets. The yen weakened so much that the U.S. Treasury supported an intervention to bolster the currency, and 10-year Japanese bond yields are trading at their highest levels in three decades.
The lesson applies broadly to high-debt countries. Many governments have drastically increased their borrowing in recent years to support their economies through a series of shocks, including the Covid-19 pandemic, the 2022 energy crisis after Russia’s full-scale invasion of Ukraine and another energy shock this year because of the war in Iran. At the same time, public spending on health care and pensions for aging populations is growing. In the short-term there are also demands, especially in Europe, to spend more on defense.
Global public debt is near its highest levels since World War II and on track to grow beyond 100 percent of global gross domestic product, the International Monetary Fund said on Wednesday. “Advanced economies are the worst offenders,” Kristalina Georgieva, the managing director of the Washington-based organization said.
In Europe, the risk is that the tumult in French bonds could spread to other eurozone debt markets such as Italy’s and trigger another regional sovereign debt crisis, reminiscent of the one in 2012.
“The situation demands an urgent and comprehensive set of policy responses,” Ms. Georgieva said. Governments need to to show credible plans to reduce their deficits even as many people have come to expect their political leaders to intervene in the face of economic shocks, she noted. This is normally done through some combination of reduced spending and higher taxes.
“Some very tough political choices stare us in the face,” she said.
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