A political shock to investors forced them to face reality, according to which the country’s budget deficit is a direct issue for and something that concerns the next few years. France benefited for a long time from the fact that investors rejected the threat posed by its bad public finances, given its central position within the euro area. This calm is in danger now, notes Bloomberg. First, President Emanuel Macron’s decision to announce early elections led to the difference between the performances of French and German bonds being widened to the greatest extent by the public debt crisis, calling into question the country’s political stability, corroding the coverage provided by his friends – business policies. Now, with the result of these elections being a politically weak parliament (as no party has an absolute majority), any new French government will have difficulty promoting more economic reforms or finding common ground in fiscal policy, with seemingly unbundled divisions in terms of taxes and state spending. As long as one notices the premium of return requested by investors to keep French bonds against the safest German securities: It ranged around 40 to 50 basis points before Macron dissolved parliament last month and is now negotiating over 60 basis points, even after markets expressed relief yesterday (8.7.2024) that neither the left nor the far right will have a majority. Societe Generale SA says the spread has probably entered a new, higher price range, especially because the “New People’s Front” was the winner – surprise in the vote. French developments are already raising questions as to whether returns properly compensate bond holders at a time of great liquidity, with voters around the world getting their frustration by voting for politicians who have won favor with unorthodox fiscal policies. Concerning debt measurements can appear to be completely dangerous within a second, a reminder that investors overlook the economic, political and social currents of individual nations at risk. Beyond France, last month showed the fragility of bond markets in countries such as Italy, where spreads have also expanded, and the US, where investors bet on inflationary incentives. Global problem Around the world, heaps of state debt have been increasing for years, swelling as governments tried to shield economies from the effects of pandemic and inflation. While it was easy to close one’s eyes when interest rates were low, the challenge of refinancing and serving such a large debt is now causing greater concern. At the same time, the highest cost of living and issues such as immigration push voters to populist and nationalist parties, which often project additional borrowing as a solution. “It’s the worst of both worlds,” Guy Miller, chief strategic analyst for Zurich Insurance Co. “We see debt levels at alarmingly high levels and at the same time we have populist parties leading or winning in polls, promising further spending.” The US, which for years had the tolerance of investors thanks to the reserve dollar regime, is increasingly worrying. A deficit approaching $2 trillion has made the bond market vulnerable to shock, a risk that will only increase if Donald Trump regains power in November 2024. The yields of the 10-year state reference bonds have risen recently, when it seems that the odds lean more in his favor. The United Kingdom has already experienced firsthand how quickly it can change the climate in the market. Liz Truss served only 49 days as Prime Minister in 2022, after her plans for sweeping unfunded tax cuts caused shock in the gold market. The new Labour government has repeatedly stated on the markets that it will seek to exercise budgetary discipline. The crisis in the United Kingdom is an effective warning example. In Italy, where debt amounts to nearly 140% of production, investors were initially frightened when Georgia Meloni was elected due to fears of increasing lending. Since then, a more conservative course has followed than expected, helping spread Italian bonds against Germany to touch low two years in March. Returning to France, the challenge will be to find a way to cope. Efforts to reach agreements began badly, with the left saying from the beginning that it would not back down from the key commitments to reverse pension reform or adjust wages to inflation. Nicolas Forest, head of Candriam’s investment, warned that the closely monitored return difference against Germany could exceed the recent peak of 86 base points. “The question concerns the medium-term period: what can we expect in terms of politics? What can we expect about the deficit?” he said. “France has become Europe’s weak man”.