Selling pressure in Europe's sovereign bond market continues to broaden. On October 8, the French 10-year government bond yield climbed to 4.897%, approaching multi-decade highs, with French government bond prices potentially heading for a sixth consecutive weekly decline.

At the same time, French fiscal and political risks are beginning to spread to the bond markets of southern European countries such as Italy and Greece, with investors demanding higher risk premiums. The sustained bond selloff has also weighed on the euro, which has fallen to a 17-month low against the US dollar.

French bonds face relentless selling, with risk spilling over to Italy and Greece

The French 10-year government bond yield edged up to 4.897% on Thursday, after posting its largest single-day increase since late September just one trading day earlier. Since bond prices move inversely to yields, the continued climb in yields means French government bond prices are under pressure.

Based on the current trajectory, French government bonds are set for a sixth straight weekly decline, making them one of the weakest-performing sovereign bond markets among recent Group of Ten (G10) monetary economies. What worries investors even more is that pressure in the French bond market has begun transmitting to other European countries.

Recently, Italian and Greek government bonds have also come under selling pressure. As international investors reassess European sovereign debt risk, the risk premiums demanded for holding French and other non-core eurozone government bonds have continued to rise. The bond market turmoil has also spilled over into foreign exchange markets.

Amid the selloff in European assets and broad US dollar strength, the euro has fallen to a 17-month low against the US dollar. Meanwhile, energy supply concerns triggered by the Middle East crisis have once again pushed up international oil prices, with Brent crude re-entering above the $100-per-barrel level. Rising energy prices have further intensified market concerns about European inflation and financing costs.

France's 2027 budget deficit projected at 5.4% of GDP, political deadlock deepens fiscal worries

The core reason behind the sustained pressure on French government bonds is the widening fiscal deficit, massive government debt issuance needs, and an intractable political deadlock. The French government's previously announced 2027 budget draft projects a fiscal deficit of 5.4% of gross domestic product (GDP), far above the European Union's 3% deficit ceiling.

This means the French government still needs to rely on large-scale debt financing to keep its fiscal operations running, and the continuously growing scale of government bond issuance has further heightened market concerns about the government's debt repayment capacity and financing costs. As the 2027 French presidential election approaches, investors are increasingly losing confidence in the government's ability to advance fiscal reduction plans amid parliamentary gridlock.

The market fears that cutting public spending could trigger greater political resistance, making it difficult for France to control its budget deficit as planned. Bank of France Governor Emmanuel Moulin acknowledged on Wednesday that France's current fiscal and economic situation is very severe, affected by the widening fiscal deficit and political uncertainty.

However, Moulin also rejected calls for central bank intervention, stating that France does not currently need emergency support from the European Central Bank.

Funds shift to German bonds for safety, ECB policy expectations turn more cautious

As investors reduce holdings of French and other high-risk European sovereign bonds, German government bonds with higher credit ratings have become an important safe-haven asset in Europe's fixed-income market. On October 8, the German 10-year government bond yield edged up to 3.498%, still near a one-month low.

The continued inflow of safe-haven funds has limited the upside for German long-term government bond yields. Meanwhile, the German 2-year government bond yield, which is more sensitive to European Central Bank policy expectations, edged down to 3.055%.

The decline in German short-term government bond yields reflects the money market's reassessment of the ECB's future rate path. On one hand, rising government bond yields in France and southern Europe are raising financing costs for businesses and governments; on the other hand, energy price increases caused by the Middle East crisis continue to weigh on eurozone inflation.

Under the dual impact of tighter financing conditions and elevated energy costs, the market expects the European Central Bank to adopt a more cautious and gradual approach to interest rate policy. The key change in Europe's bond market currently is that France's fiscal risk is gradually evolving into broader regional asset pricing pressure. Investors are reducing holdings of French and southern European government bonds while increasing allocations to German government bonds as a safe haven, further diverging financing costs for sovereign bonds within the eurozone.