French Equities and Sovereign Debt Under Political Strain: ECB's Balancing Act and Investor Distrust

France's political turmoil in 2025 has triggered a dual crisis in its equities and sovereign debt markets, testing the resilience of both the European Central Bank (ECB) and investor confidence. The abrupt resignation of Prime Minister Sébastien Lecornu in early October 2025-amid a fractured parliament and stalled reforms-has deepened fears of institutional paralysis, sending shockwaves through financial markets. The CAC 40 plummeted 1.36% on the day of his resignation, with banking stocks like Société Générale and BNP Paribas tumbling over 3% as lenders faced heightened credit risk perceptions, according to a Le Monde article. Meanwhile, French 10-year OAT bond yields surged to a 90-basis-point spread over German Bunds, the widest since 2012, reflecting investor concerns over fiscal sustainability and delayed structural reforms, Euronews reports.

The ECB now faces a precarious balancing act. While its Transmission Protection Instrument (TPI) allows for bond purchases to counter "unjustified" market stress, France's eligibility remains ambiguous. Analysts argue that the ECB could intervene if volatility threatens eurozone stability, even if Paris falls short of strict TPI criteria, a point noted by Euronews. However, such action risks normalizing bailouts for politically unstable governments, undermining the ECB's credibility. The specter of a "Frexit"-though remote-has further amplified tensions, with some fearing that extreme political fragmentation could force France into a currency exit or financial isolation, DW analysis suggests.

Investor confidence metrics underscore the fragility of the situation. The 2025 Kearney Foreign Direct Investment Confidence Index® highlights efficiency in legal processes and domestic economic performance as top priorities for global investors, a point covered by Euronews. Yet French government bond yields have climbed to 4.50% for 30-year paper, a level not seen since 2009, while the OAT-Bund spread approaches 100 basis points, as reported by Le Monde. These trends signal a self-reinforcing cycle: rising borrowing costs worsen debt dynamics, which in turn erode confidence. With public debt projected to hit 120% of GDP by 2027, Strategy International projects, France's fiscal trajectory is increasingly unsustainable without political compromise.

The ECB's recent policy shifts have exacerbated vulnerabilities. In January 2025, the bank ceased repurchasing sovereign debt, a move that immediately raised France's borrowing costs and intensified market scrutiny, according to Strategy International. While the ECB has not ruled out TPI use, any intervention would likely come with stringent conditions-such as accelerated fiscal reforms-that France's divided parliament may reject until a crisis becomes unavoidable, Le Monde cautions. This creates a dangerous lag, during which private investors could flee French assets, further straining the government's ability to service debt.

Two scenarios now dominate market discussions. The first envisions a stabilization path: President Macron dissolves parliament, calls snap elections, and secures a mandate for reforms, restoring investor trust. The second-a worst-case escalation-sees political deadlock persist, pushing France toward a debt crisis and triggering contagion across the eurozone, particularly in Germany and Italy, as observed by DW.

For investors, the lesson is clear: France's markets are no longer insulated from political risk. The ECB's tools are limited, and investor confidence is a fragile commodity. As one strategist notes, "The calm before the storm may be ending. Markets are pricing in a crisis, not a resolution." Strategy International similarly warned of mounting vulnerabilities in its recent analysis.