What France’s surging bond yields and rising debt mean for Canadian borrowers

France is facing ongoing protests, high government debt and growing speculation among economists about whether it is nearing another eurozone crisis. As government bond yields rise worldwide, Canadian investors and borrowers are watching closely. TD Bank senior economist Vikram Rai said in a statement Wednesday that French government bond yields rose more sharply than those in the United States and many other developed economies during the recent sell-off, reflecting greater concern about political uncertainty and a weak fiscal outlook. Long-term yields have climbed across major markets, but the move in French bonds has been outsized.

Bonds are investments issued by governments and companies as loans for fixed terms. Bondholders receive regular yield or interest payments during that term. Yields fluctuate with economic factors and supply and demand. Bonds have been selling off since the start of the year, particularly since the Iran war began, pushing yields higher as issuers seek to attract investors. The U.S. Treasury yield has risen above five per cent in recent months, and some French government bonds have followed suit.

France, like many countries, has a debt problem. Its sovereign debt is now close to 120 per cent of GDP, meaning a substantial share of government revenue, including tax revenue, goes toward interest on borrowed money. Rising interest costs are putting pressure on public finances. Investors who lose confidence in a government’s ability to repay its debt may sell its bonds because of perceived risk. France’s impending election period is another source of uncertainty about the country’s future fiscal strategy.

Yoshio Nozawa, a finance professor at the University of Toronto, said French government debt is about 120 per cent of GDP, twice the level set out in the EU standard, and investors are more concerned about the country’s prospects. If populist leaders are elected, he said, the deficit problem is expected to worsen. Together, those factors are raising concerns about the French government’s ability and willingness to narrow the gap between spending and tax revenue.

Rai said the yield on France’s 10-year government bond, the Obligation assimilable du Trésor (OAT), is hovering near five per cent, its highest level since 2002 and up from about 3.5 per cent in June. At the time of publication, the 10-year U.S. Treasury yield was about five per cent. That was down from a recent peak of 5.3 per cent, but remained above roughly four per cent in March. Canada’s 10-year bond yield was about 3.8 per cent, up from just over three per cent in March.

Doug Porter, chief economist at the Bank of Montreal, said in an Oct. 2 note to investors that the bond sell-off took a darker turn this week, with yields suddenly rising faster across much of Europe, especially France. French 10-year yields have jumped more than 100 basis points, or one percentage point, since early August amid mounting fiscal concerns. Porter and Rai both noted that the spread between French and German 10-year yields has widened to more than 1.5 percentage points in recent weeks, its highest level since the euro crisis peaked around 2011 or 2012.

At that time, Greece faced major sovereign debt problems, raising fears of wider financial instability and threatening the future of the euro as a currency. Nozawa said the current situation may be reminiscent of that crisis, but France’s economic position could make it less concerning for now. He said the earlier crisis was a serious concern that spread beyond Greece to Italy and Spain, as investors feared similar problems could affect other more vulnerable European members. France is a large economy and is not Greece. Its position as a major EU member is concerning in some respects, Nozawa said, but its observed borrowing costs and deficit do not put the situation on a par with 2010.

The Bank of Canada sets the floor for borrowing rates commercial banks can offer households and businesses, which usually affects variable-rate loans. Longer-term fixed-rate products are more often determined by global bond yields. France’s debt issue may not directly affect Canada’s economy, but Canadian yields could also rise if French yields increase, in order to remain competitive. So far, Canadian borrowers may be in a relatively better position than borrowers in the United States and France.

Porter said Canadian yields have felt the pull of rising global yields but have mostly remained calmer. Canada’s cooler growth backdrop, partly because of trade tensions, slightly milder inflation and less strained government finances have helped dampen the rise in yields. He said Canada’s fiscal sustainability is much less of an issue than it is elsewhere.

Regardless of how Canada’s bond market performs compared with those of other countries, Nozawa said the relative cost of borrowing for some loan products is still likely to increase. Long-term government bond rates tend to move in step across countries, he said, partly because large global investors hold diversified portfolios that include Canadian, U.S. and French government bonds. When the interest rate on one rises, the others also have to rise to maintain a balance among the three.