Strategic Asset Allocation in the Eurozone Amid French Political Uncertainty

The political instability gripping France in 2025 has emerged as a critical focal point for European markets, with cascading implications for fiscal policy, investor sentiment, and strategic asset allocation. The resignation of Prime Minister Sébastien Lecornu and the subsequent gridlock in forming a stable government have triggered a sharp rise in country risk, as evidenced by French 10-year bond yields trading at an 86-basis-point premium over German equivalents-a level not seen since March 2025. This widening spread signals eroded confidence in France's ability to manage its fiscal challenges, with public debt projected to exceed 116% of GDP by 2026.

Economic Implications and Market Reactions

The economic fallout is already materializing. ING estimates that France's growth could contract to 0.8% in 2026, lagging the eurozone average, while the CAC 40 index has underperformed other European benchmarks by 14% year-to-date. French banks, including BNP Paribas and Société Générale, have seen share prices decline amid heightened exposure to domestic sovereign risk, according to BNP Paribas's Investment Strategy Focus. The European Central Bank (ECB) faces mounting pressure to intervene via its Transmission Protection Instrument (TPI) to stabilize markets, though such action remains contingent on strict conditionality.

Meanwhile, France's weakened geopolitical role-exacerbated by stalled defense projects like the Future Combat Air System and Main Ground Combat System-has fragmented EU strategic cohesion, as discussed in Carnegie Endowment's Taking the Pulse. This erosion of leadership complicates collective efforts on energy security and European enlargement, further amplifying uncertainty for investors.

Strategic Asset Allocation: Shifting Priorities

In response to these dynamics, institutional investors are recalibrating Eurozone portfolios. German government bonds have gained favor as a safe-haven asset, supported by a EUR 500bn infrastructure stimulus package and structural reforms, according to BNP Paribas. European credit, particularly in sectors with strong fiscal backstops, is also being prioritized over U.S. or emerging market debt due to narrower spreads and a more favorable interest rate environment, a trend highlighted by several strategic assessments.

Conversely, French sovereign debt is being approached with caution. Goldman Sachs notes that France has experienced the largest rise in country risk among major markets since the 2024 elections, prompting a reevaluation of exposure. Investors are advised to hedge against prolonged fiscal gridlock, which could delay reforms and trigger non-compliance with EU fiscal rules.

Geopolitical Risk and Diversification Strategies

Geopolitical risks, including the Russo-Ukrainian war and the Gaza conflict, have further complicated the investment landscape. The Eurozone's geopolitical risk index (EA GPR) has surged, correlating with higher sovereign bond yields and increased volatility, according to the ECB's geopolitical-risk page. MSCI research underscores that periods of elevated geopolitical risk are associated with lower equity returns and heightened forecast uncertainty.

To mitigate these risks, European banking supervisors recommend integrating geopolitical scenarios into stress testing and capital planning. Diversification across asset classes and regions-particularly into core European credits and inflation-linked bonds-is being emphasized to balance exposure.

Conclusion: Navigating Uncertainty

The French political crisis underscores the fragility of governance in the Eurozone, with far-reaching consequences for market stability. While the ECB retains tools to contain spillovers, long-term solutions depend on political clarity and fiscal discipline in Paris. For now, investors must navigate a landscape defined by elevated risk premiums, fragmented EU coordination, and the specter of prolonged semi-governability. Strategic asset allocation will hinge on agility, with a focus on core European assets and robust risk management frameworks.