As the premium investors demand to hold French 10-year bonds over safer Germany shot above 150 basis points on Friday, talk began to grow about how severe the selloff could become and whether neighboring countries can be shielded with the help of the European Central Bank (ECB).
France's 10-year bond yield rose to near the 5% mark, hitting its highest since 2002. The premium investors demand to lend to France, rather than Germany, was set for its biggest weekly jump since at least 2007, with a rise of at least 40 basis points, according to LSEG data .
"The speed at which the spread has got here is what is concerning," said Seema Shah, chief global strategist at Principal Asset Management.
While some investors hope the ECB will intervene, the central bank is "caught between a rock and a hard place" as it would have to consider buying bonds while tightening monetary policy, she said.
The ECB's Transmission Protection Instrument allows it to buy an unlimited number of bonds from any euro zone country experiencing an "unwarranted, disorderly" tightening of its financing conditions.
The ECB is not expected to use that tool to contain the pressure on France, but analysts say this week's heavy selling - whichhas also rippled across to Italian bonds - raises pressure on the central bank.
Italy's 10-year bond yield rose on Thursday to its highest since 2023 as investors have flocked to safe-haven debt.
"Italy has been relatively stable, so this selloff this week has been a concern," Shah said.
Elevated energy prices, rising inflation and higher interest-rate expectations have hurt sovereign bonds worldwide, causing pain for consumers and businesses as higher government borrowing costs spill over into the real economy.
French debt has been hit especially hard due to concerns about the government's ability to cut spending and improve its finances ahead of the 2027 presidential election.
France on Thursday presented its 2027 budget bill, seeking to enact unpopular belt-tightening measures that can lower its deficit.
"If the ECB believes there's going to be a threat to financial stability, they will use whatever tools they have available," said Marion Le Morhedec, CIO of fixed income at Fidelity, adding that this could include the TPI.
She added that activity by hedge funds, which have stepped up trading across European government bond markets in recent years, has played a role in the sharp selloff in French bonds.
Some analysts said the French-German bond spread could widen further.
Analysts at JPMorgan said in a note that a liquidation of positions by investors has exaggerated the moves in French bonds.
"In our view, political noise risk, alongside elevated global rates volatility, keeps investors cautious on France despite increasingly attractive valuations," they said.
