France is in the midst of its most significant social unrest in many years, with protests initially centred around the lack of education reforms and underfunded schools, before broadening out to wider dissatisfaction over cost of living, high fuel costs, and deteriorating public finances. Amid episodes of sporadic rioting, the government has imposed localised overnight curfews to bring the situation under control.
Italy also faced protests in several parts of the country accompanied by instances of rioting as residents highlighted poor education conditions, besides emerging economic pressures and high inflation. Truckers also held protests over soaring fuel prices, which triggered shortage in supplies to supermarkets and other retail outlets. PM Meloni deployed the army and announced tough anti-riot laws to quell the gatherings.
Political and budgetary worries, alongside unrest across two regions, have sparked the markets through widening bond spreads and a higher sovereign risk premium. We also see likely cautious commentary on sovereign ratings, especially for France. French 10Y OAT and Italian 10Y BTP yields rose past to 5% and 4.5%, respectively, widening its spread vs German bunds to more than 150 bps and 110 bps respectively. Domestic equities also have underperformed its peers as the concerns weakened investors’ appetite.
Macroeconomics | Radhika Rao
For France, the timing of the protests is sensitive as the authorities seek to advance a 2027 budget. The proposed consolidation not only assumes lower spending on controversial areas including welfare, state-sector wages, and pensions, but also imposes a higher tax burden. The math also rests on an optimistic growth assumption of 1.0% in 2027, vs sub-0.5% forecast this year. A delay in budget rationalisation efforts could push public debt to GDP ratio above 120% of GDP. In the wake of the 2018 yellow vest protests, Banque de France had halved its growth projection for 4Q18, while Finance Minister Maire had projected c.0.1 %pts hurt to annual growth, amid already slowing growth momentum. This year, if signs of disruption persist (unions have called for more protests towards late-Oct and early-Nov), a broader loss of confidence could entail a bigger economic price through lower consumer spending and damage to tourism and logistics.
Moreover, in the efforts of mollifying protestors, Italy PM Meloni’s cabinet approved a EUR1bn aid package targeting truck drivers and farmers to offset fuel cost spikes and encourage fleet modernisation. Budget troubles are likely to linger with the draft 2027 Budget including tax cuts and increase in spending worth c.1% of GDP. Fiscal deficit is expected to widen to 3.4% of GDP in 2027 vs 2.9% in 2026, contributing further to the debt to GDP ratio, which is approaching 139% of GDP, amongst the highest in the Eurozone.
France and Italy are increasingly trading in a high-fiscal-risk, low-growth, weak-political-capacity loop, which is likely to keep bond yields high and pose a risk to the euro in case of spillovers to other member countries. A swift response from the European Central Bank (ECB) is not on the cards, given the localised nature of these challenges as yet.
Equities | Joanne Goh, Chloe Park
We expect limited spillover to the wider regional equity market, as YTD gains have been concentrated in select companies benefitting from Europe’s differentiated exposure to the AI investment cycle, elevated energy prices, and higher interest rates. However, with French political uncertainty likely to persist ahead of the Apr 2027 Presidential Election and unrest potentially spreading elsewhere, we remain cautious on sectors most exposed to domestic policy risk. We continue to prefer Germany over France, given Germany’s stronger fiscal impulse and clearer domestic growth catalysts, while France has greater exposure to luxury companies, where we remain cautious amid a delayed recovery in Chinese demand.
Although we retain our underweight stance on Europe equities, the recent de-rating has created selective opportunities in sectors supported by global structural investment such as AI beneficiaries (semiconductors, industrials, utilities, and renewable energy) and energy with strong earnings growth and cash flow.
Rates | Eugene Leow
Contagion worries are apparent as we look at European Government Bond (EGB) spreads over the past few weeks. French budget issues, unrest and next year’s Presidential elections in April have been weighing on OATs. For a while, OAT weakness appears to be contained. However, with unrest also breaking out in Italy, BTPs have also come under selling pressure. We remain defensive on EGBs given no immediate catalyst on the horizon that may be able to shift sentiment to be more positive. The fact that OAT weakness has spread to BTPs and to a smaller extent, the other peripheral government bonds suggest that some contagion is already taking place. 10Y OAT-Bund spreads (currently > 150 bps) are wide by historical standards (wider than during the Eurozone crisis of 2011/12). However, we should note that France was in a stronger position back then. A more appropriate comparison of stress would be BTP-Bund spreads. While 10Y BTP-Bund spreads have widened beyond 110 bps, these levels are still a far cry from the 300-500 bps spread seen during the height of the Eurozone crisis. As things stand, we see scope for stresses to build and for investors to seek safety in Bunds. If stresses worsen, ECB hike bets would have to be pared. For the ECB to intervene, we would need the OAT-Bund spread to head materially wider (perhaps into the 250-300 bps area) before speculation of ECB QE becomes live.
FX | Philip Wee
We continue to monitor the impact of widening sovereign bond spreads in France and Italy on the EUR. Based on the strong relationship between the 10Y OAT-Bund spread and EUR/USD from Sep to early-Oct, a 150-170 bps spread could pressure EUR/USD to 1.10-1.11, with further widening to 180-210 bps pointing to 1.07-1.09, and a 220-250 bps spread to 1.04-1.06.
However, this relationship has weakened over the past two weeks, with EUR/USD diverging from widening spreads. If sustained, this decoupling would suggest that the EUR/USD’s decline over the past month was driven as much by US monetary policy expectations as by EU fiscal concerns. Before this week’s Fed blackout period, Fed officials pushed back against expectations of further Fed tightening in 2027, which weighed on the EUR.
Importantly, markets should distinguish between a repricing of sovereign credit risks and a systemic debt crisis. Widening spreads reflect rising fiscal premiums but do not necessarily signal a repeat of the 2011-2012 Euro Area crisis, when sovereign funding stress, banking vulnerabilities, and contagion threatened the integrity of the monetary union. Thanks to that crisis, the ECB now has stronger safeguards against financial fragmentation today, although their deployment remains conditional. For now, the EUR faces a sovereign risk-premium problem rather than an existential crisis. EUR should remain sensitive to shifts in Fed expectations that affect the USD’s direction, rather than to European fiscal concerns alone.
Fixed Income | Daryl Ho
France's fiscal and political risk premiums have blown out in the fixed income markets as 10Y OATs crossed the 5% handle for the first time in more than two decades, with the OAT-bund spread exceeding 170 bp, the widest since the European sovereign crisis. This was a result of escalating debt compounded by unrestrained deficit spending, a refrain common across several developed fixed income markets today. With France being a relatively large weight in European bond indices, large French corporates and bank papers are expected to trade with greater volatility while such uncertainty remains, although we believe the fundamental strength of the underlying issuers would ultimately weather the storm. Moreover, the ECB has an available Transmission Protection Instrument (TPI) – a bond purchase programme designed to counter disorderly market dynamics; like the past, they are likely to do "whatever it takes" to restore financial stability in the Eurozone when push comes to shove.
This, however, calls once again for duration caution, given that debt sustainability is not merely a France issue; curve steepening risks remain present across much of the developed markets. Seeing as the long end carries the most duration and political-premium sensitivity, portfolios should remain in the 5-7Y bucket to avoid sudden shocks. Our preferred BBB/BB credit sweet spot also reflects a preference to extend credit risk over duration risk to harness yields.
Private Credit | Elijah Tan
Prolonged political unrest in France and Italy can add to the uncertainty around the European private sector, with the potential to weigh on earnings. Simultaneously, heightened fiscal concerns could further increase sovereign risk premia and bank funding costs, tightening traditional lending conditions and driving greater demand for alternative sources of finance. This environment may, in principle, allow private lenders to secure wider spreads and stronger creditor protections. However, weaker growth and higher borrowing costs could also intensify refinancing pressures and increase default risk, particularly among highly leveraged companies. In line with our neutral stance on private credit, we remain selective, focusing on senior-secured, first-lien loans to established middle-market borrowers with resilient cash flows, conservative leverage, and manageable maturity profiles. Ultimately, attractive lending terms must be underpinned by robust borrower fundamentals to generate sustainable risk-adjusted returns.
Figure 1: France and Italy bond yield spread vs Germany have widened significantly
Source: Bloomberg, DBS
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