France’s 10-year bond yield touches 5%, its highest level since 2002

What happened

The Financial Times (FT) reported that worries over public finances and political stability have lifted France's 10-year yield from 3.2% in late February to 5%. CNBC said the benchmark bond, known as the OAT, passed the 5% mark shortly before 11:30 a.m. Paris time on Wednesday before easing to roughly 4.98%, still about 6 basis points (0.06 percentage points) up on the day. AFP put the gap over equivalent German debt at about 1.6 percentage points. The move comes as lawmakers negotiate next year's budget, after a weekend of violent protests, and two days before Moody's is due to decide on France's credit rating.

What it means

A bond yield is the annual return a buyer locks in, and it rises when prices fall. So a 5% yield means investors have been selling French debt and now want a much bigger reward for holding it. Our earlier coverage looked at the protest-driven sell-off; what is new is that the yield has now crossed a psychological line that had held for more than two decades.

The core worry is arithmetic. According to AFP, France's debt is close to 120% of its economic output, against about 66% in Germany, and the EU's ceiling is 60%. CNBC noted the deficit stood at 5.1% of GDP at the end of last year and that France is under the EU's excessive deficit procedure, which pushes it toward 3%. Even if this year's plan passes, it would only bring the shortfall down to 5% next year. Reports differ on how much the government wants to cut: CNBC cited 54 billion euros, while a report carried by Yahoo Finance gave 43 billion euros.

Politics makes the numbers harder to fix. Finance minister Roland Lescure told RTL radio the government could again use Article 49.3 of the constitution, which lets a bill pass the lower house without a vote, as it did to force through this year's budget in February. Bond traders are also eyeing next spring's presidential election as a further source of uncertainty.

Investors may hope the European Central Bank (ECB) will step in, but that looks unlikely for now. The ECB's Transmission Protection Instrument, its tool for buying a country's bonds during disorderly sell-offs, is meant for moves not justified by a country's fundamentals, and its own eligibility criteria include not being under an excessive deficit procedure. ECB President Christine Lagarde said this month that the first solution "lies at home in France," according to AFP. That leaves Friday's Moody's decision as the next big test: Yahoo Finance reported that most economists expect a downgrade.

The bull case

The yield slipped back below the 5% line within hours, suggesting buyers still step in at these levels. If the budget passes on time, as the finance minister insists it will, and Moody's outcome is already priced in, some investors may come to view French debt as offering one of the higher returns available among large eurozone borrowers.

The bear case

The trend is the problem: a rise from 3.2% to 5% in about eight months, by the FT's account, shows confidence draining steadily. A Moody's downgrade could push yields higher still, the ECB has signaled no rescue, and protests and a looming election limit how far any government can cut. Higher state borrowing costs also eat into money available for public services, which could feed the unrest further.