Foreign Investors Retreat From French Bonds, Raising Fears of a Debt Crisis

A shop in Paris that was looted over the weekend. Warnings of a potential fiscal crisis in France are mounting as foreign investors show signs of pulling back from a market they have long helped support. Foreign investors hold about 55% of French government bonds, a significantly higher share than in the United States at 31% or Japan at 13%, leaving France vulnerable to external shocks. Concerns are intensifying that Japanese investors, estimated to hold 10% to 15% of French government bonds, could repatriate funds as interest rates rise at home. On Oct. 22 (local time), the yield on France’s 10-year government bonds climbed above 5% for the first time since 2002, reaching an intraday high of 5.1415%. It also exceeded the yield on the U.S. 10-year Treasury, cited at 5.050%, marking a rare reversal between the two countries’ borrowing costs. The spread between French and German 10-year bond yields, meanwhile, widened beyond 1.6 percentage points, reaching its widest level since the eurozone debt crisis in 2011. Market experts identify changes in Japanese monetary policy as a major threat to the French government bond market. Japanese investors have historically invested heavily in higher-yielding French government bonds to escape ultra-low interest rates at home. But as domestic yields in Japan rise, the incentive to hold overseas assets has weakened. Claus Vistesen, chief economist at Pantheon Macroeconomics, said rising Japanese interest rates were fueling expectations that capital could flow back to Japan, describing the prospect as a significant vulnerability for France. There are already signs of investors pulling back. A Japan-based Sumitomo Mitsui fund reportedly sold its entire holdings of French government bonds, citing France’s deteriorating fiscal position, and reallocated the proceeds to German and Japanese government debt. Japanese life insurers have also reduced their holdings of French bonds since 2022, reportedly as higher European Central Bank interest rates increased the cost of currency hedging. France’s domestic political and social turmoil is adding to investor concerns. The government’s deficit-reduction plans have yet to win market confidence, while recent large-scale protests and violence have raised doubts about its ability to implement spending cuts. Morningstar estimated that insurance losses linked to the unrest could reach as much as 1.2 billion euros, warning that prolonged unrest could weigh on economic activity and add to fiscal pressure. France also faces an unprecedented financing burden in the years ahead. More than $1 trillion in government bonds are due to mature by 2030, while the country is expected to issue about $380 billion in new bonds next year alone. Refinancing debt issued during the era of low interest rates at today’s higher yields is expected to push up debt-servicing costs sharply. France’s fiscal deficit reached 5.1% of gross domestic product last year. The possibility of a sovereign credit rating downgrade by Moody’s is another immediate concern. Investors expect the agency to review France’s rating on Oct. 23, with a one-notch downgrade seen as a possibility. Such a move could prompt conservative investors, including central banks and foreign reserve managers, to stop buying French bonds or reduce their holdings. Konstantin Veit, a portfolio manager at PIMCO, said the firm would maintain a cautious stance unless French political leaders presented a credible plan to reduce the deficit.