In about eight months, French citizens will head to the polls to elect their next president. The French system is different than our system here. Anywhere between 10 and 15 candidates will typically run in a ‘first round’ followed by a second run-off that pits the two best performing candidates of the first round. Current French President Macron isn’t allowed to run again due to the two-term limit rule. He’s also wildly unpopular according to polls which leaves the door wide open.
As it stands right now, Marine Le Pen on the right is one of the clear favorites with Jean-Luc Melenchon on the left as a real sound-round possibility. Neither outcome is clean for French markets.
As one can imagine, Le Pen is running on immigration, law and order and a tighter grip on public spending. Unions won’t be pleased and would most likely strike. Left-wing unions would be able to shut down transportation (rail, airports), energy (refineries, ports), and education leaving the country facing a temporary growth shock.
On the other side, if Melenchon wins, he has proposed taking approximately 18% of French debt and either canceling it, freezing it, or turning it into perpetual debt at zero rates. This is a radical plan to tackle the massive deficit that the French government faces.
French bond markets have taken notice of both paths. French bond rates are now higher than Italy, Greece, Spain and Portugal – a ranking that would have sounded absurd a decade ago. French yields are also well above the country’s structural growth rate, which sits closer to 1 percent. When the interest rate on the debt is higher than the growth rate of the economy, and the government is still running a large primary deficit like France is, a debt trap becomes the obvious conclusion.
This is not just a French story. It is the same story wearing different flags.
Since 2020, long-term government bonds have been a miserable asset class for the job they were supposed to do. Japanese bondholders have taken large losses as yields climbed off zero toward 3 percent. US long-bond holders over the same period are still digging out of 2022, and even the flatter total-return picture gets eaten by inflation. German bund holders who locked in negative yields a few years ago have negative returns. Bonds may be remembered in this decade as a big disappointment for investors who looked for stability, income, or diversification.
The problem for bonds is similar in most places. Governments almost everywhere — especially the United States, the United Kingdom, and France — are running deficits that are far too large for this stage of the cycle. Many of those same governments have leaned into protectionism, central banks have been sitting on their hands dealing with inflation, and the world is still living with economically destructive wars. On top of that, the buildout of AI is a real competitor for capital. This creates a difficult situation when both the private and public sectors are trying to chase the same dollars.
In short, almost all the policy settings (fiscal, monetary, trade, diplomatic, immigration, etc.) sit firmly in the inflationary world. This has been a theme of mine since I’ve started writing publicly. Bond markets are finally starting to take notice.
Rapid increase in interest rates showed up in Japan last year and it is showing up in France now. It has been threatening to show up in the United States as yields went up this month enough to trigger Treasury Secretary Scott Bessent to step in with what markets are calling a Treasury twist. Put simply, the Treasury is expanding buybacks of long-dated bonds — think 10- and 30-year paper — and funding that by issuing more short-term bills. Officially this is about liquidity. In practice, the goal is obvious: take pressure off the long-term interest rates (30-year yields) before they dictate terms/cost of everything else. The likely side effect is a weaker dollar, which again, is something President Trump has been longing for.
France is the clearest political version of a fiscal problem and potential debt trap that markets can no longer ignore. The US is the largest version of the same problem with the Treasury now trying to put a cap on both long-term interest rates and the US dollar. This raises a question that I don’t have an answer for: having the reserve currency of the world does allow the US to play by a different playbook, but for how long?
I can conclude however, that interest rates in the US are too low. And if interest rates in the US do continue to rise towards the level they should be, rates will probably rise in France and the UK as well, pushing them into a solvency crisis. The only solution would be a U.S. recession but none of my tools point to such an outcome. In fact, quite the contrary.
