French crisis hits the euro

EUR/JPY

Key zone: 176.50 - 178.00

Buy: 178.50 (on strong positive fundamentals); target 180.00; StopLoss 177.80

Sell: 176.00 (on a pullback following a retest of 176.50) ; target 173.50; StopLoss 176.70

French authorities face a dual challenge: social discontent is driving demands for additional spending, while the government bond market is signaling declining confidence in the country's fiscal policy. Investors are demanding a higher risk premium on French debt.

With government debt exceeding 119% of GDP and yields on 10-year OATs approaching 5%, any expansion of permanent government spending commitments makes reducing the deficit more difficult.

A Quick Recap:

Mass protests by school students, which began on September 21, have spread beyond individual schools and taken on a nationwide scale. For the Lecornu government, this represents an additional political risk amid disagreements over the 2027 budget. For financial markets, however, the protests themselves matter less than their potential impact on Paris's ability to contain spending and restore creditor confidence.

Social Demands Raise the Cost of a Budget Compromise

As of October 9, more than 6,800 people had reportedly been detained, while preliminary estimates put damage to school infrastructure at €30 million. The Ministry of Education is also considering hiring approximately 3,000 additional teachers.

The direct costs of repairing damaged buildings are relatively small in the context of the French economy. Far more significant would be the consequences if the authorities were forced to increase long-term allocations for teacher salaries, staff expansion, school modernization, and social programs.

The scale of the school protests matters primarily as an indicator of how politically difficult it is to cut government spending. If the government gives in to the demands of social groups without offsetting measures, achieving its fiscal targets could become even more challenging.

French Bonds Are the Key Indicator of Market Stress

The condition of public finances is reflected not only in absolute OAT yields but also in the difference between French and German borrowing costs. The OAT–Bund spread measures the additional yield investors demand for holding French debt instead of German government bonds.

Since late August, this premium has widened by approximately 56 basis points. However, the current reading remains below the October peak of around 147 basis points. This indicates some easing of market tensions but does not confirm a full restoration of confidence in French public finances.

On October 14, ECB President Christine Lagarde emphasized that France must address its debt problems through its own fiscal policy. This limits the grounds for expecting immediate intervention by the central bank to stabilize the French bond market.

A deterioration in France could spread beyond the government bond market. Rising yields increase the cost of capital, change financial institutions' risk assessments, and may worsen financing conditions for businesses. If pressure on French debt persists, investors may also reassess their exposure to other European assets.

So What Is the Bottom Line?

School protests do not independently threaten the financial stability of the eurozone. Their significance for markets lies elsewhere: social pressure could complicate deficit reduction at a time when investors are demanding convincing evidence of fiscal discipline from France.

The primary risk is not an immediate default, but a gradual increase in borrowing costs, deteriorating financing conditions, and declining attractiveness of European assets relative to dollar-denominated instruments.

An alternative scenario also remains possible. If the government reaches an acceptable budget compromise and convinces investors that its consolidation plan is realistic, France's risk premium could narrow. This would create conditions for covering speculative short positions in the euro and support its recovery.

The situation is certainly weighing on the euro, but it does not guarantee further declines in EUR/USD. For event-driven trades, it is advisable to limit risk per position to 0.5–1% of trading capital and account for aggregate exposure to correlated instruments, including EUR/USD and the CAC 40.

So we act wisely and avoid unnecessary risks.

Profits to y’all!