France emerges as Europe’s new bond-market basket case, and Marine Le Pen could make it worse

When Giorgia Meloni won Italy’s election in September, 2022, the Italian bond market suffered a mild anxiety attack.

Italy, a highly indebted G7 country running fat budget deficits, had just elected a far-right leader with vaguely Euroskeptic leanings and no economic background. Yields on Italian bonds rose. The new Italian prime minister would be no Mario Draghi, her sober-minded economist predecessor – or so investors thought.

Instead, Ms. Meloni, whose Brothers of Italy party will soon begin campaigning in the 2027 election, surprised the market. While outwardly populist, anti-migrant and nationalistic, her inner fiscal pragmatist soon surfaced.

Her plan: align Italy with the European Union and NATO, appoint a sober, mindful treasury minister, Giancarlo Giorgetti, reduce the budget deficit and – above all – respect the bond-market gods. The Liz Truss debacle obviously haunted her. The former British prime minister’s unfunded tax cuts blew up the U.K. bond market, triggering her resignation in October, 2022, after only 50 days on the job.

While up since the United States and Israel began bombing Iran on Feb. 28, sending oil prices soaring, today Italian bond yields are tame. The spread over equivalent German bonds was 2.5 percentage points in the month that Ms. Meloni became prime minister; today, the gap has narrowed to 1.1 points, well below France’s 1.4 points.

Who would have thought that Italian debt would become less risky than France’s?

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France, the EU’s second-biggest economy, has replaced Italy and Greece as the continent’s debt, deficit and bond basket case – and the problems are bound to multiply, possibly infecting the rest of the euro zone. Remember the “contagion” effect during the Greek-inspired 2011-12 financial crisis, when borrowing costs rose all over the European map?

Get this: Some 38 per cent of France’s high-grade corporate debt this week traded at lower yields than allegedly safe French government debt of equivalent maturities, according to Bloomberg data, after a savage sovereign bond sell-off.

How did France get into such a mess?

French governments love to spend. The last time the government ran a balanced budget was in 1973. France has not met the EU’s 3-per-cent deficit cap since 2019. For the past three years, the budget deficit has been 5 per cent or greater. The 2026 forecast is 5.4 per cent.

Every prime minister’s and finance minister’s plans to crunch spending and raise revenue to keep the deficit in check has failed. No wonder France’s debt is 120 per cent of GDP – the third-highest in the euro zone, after Greece and Italy – and rising.

Persistent low growth has not helped. On Friday, the yields on French 10-year debt were just above 4.8 per cent, the highest since 2002. The recent peak was nearly 5 per cent, a shocking figure for a country that, along with Germany, was considered the euro zone’s anchor of stability.

To try to calm the markets, French Prime Minister Sébastien Lecornu has proposed some €54-billion in spending cuts and tax hikes for next year’s budget. Only defence spending has been spared the knife. But even if the budget passes, it would barely put a dent in the deficit, merely keeping it at 5 per cent.

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A more ambitious campaign to punch a hole in the deficit is certain to meet strong resistance in parliament, where Mr. Lecornu is hobbled by a minority government. The government could fall, even though it has the constitutional ability to force through a budget without a vote – the Article 49.3 nuclear option. French streets are full of protests against the underfunding of schools, and more public spending cuts could hobble the country.

The inevitable budget clashes are likely to rattle bond investors. So will the 2027 French presidential election.

You can bet Marine Le Pen, the far-right National Rally politician who is leading the polls – Emmanuel Macron cannot run again – is watching the bond debacle with a mixture of awe and anguish. If she wanted to play it safe, even at the risk of not implementing some of her cherished giveaway programs, she would take a lesson or two from Ms. Meloni. She may not; her economic and fiscal platforms are muddled and sometimes contradictory, as are those of her main rival, the far-left leader Jean-Luc Mélenchon.

Ms. Le Pen’s plan to fix government finances is unrealistic. She has called for a national debt limit of 60 per cent of GDP. Implementing such a law would probably plunge the country into recession, or worse. At the same time, she wants to lower the retirement age for some categories of workers and reduce taxes on energy.

Mr. Mélenchon’s plan? He said he wants to “set fire” to a big swath of public debt by having the European Central Bank waive interest payments on some French bonds. Good luck with that.

You can see where this is going. The French bond markets could remain in turmoil for some time. Meanwhile, in Rome, Ms. Meloni is smiling. Italy was supposed to emerge as the new debt basket case under her populist government. Instead, it is France. She awaits a knock on her door from Ms. Le Pen.