Market Review 5th October 2026
Everything you need to know, Simplified!
France's fiscal woes are a warning shot to the UK
Summary
Bond markets were again the greatest source of volatility, with French OATs (sovereign bonds) at the epicentre of the global sell-off; the rout reflected deepening investor concern over France's missed deficit targets and political gridlock; the OAT-Bund spread widened to 140 basis points (bps), a level last seen in 2012 during the Eurozone debt crisis; UK gilts performed relatively well by comparison.
Economic data was mostly healthy with economic growth in the second quarter revised higher for both the US and the UK; global manufacturing activity continued to grow, according to recent data; the September US labour market report was the weak spot as job growth came in at 29,000 well below expectations, job growth in July and August was also revised lower by 60,000
Energy prices remained volatile with Brent crude oil rising above US$108 a barrel (bbl) earlier in the week before settling at US$102/bbl; the G7 nations announced plans to release as much as 100 million barrels of emergency oil and diesel reserves following pressure from the Trump administration; the deal followed a US threat to restrict diesel exports unless European countries agreed to release reserves.
Market Review
France's fiscal reality - should the UK be concerned for themselves?
Friday saw a sharp rally for global bonds and it’s not unusual during bear markets to see very good days - they usually follow particularly nasty selloffs. What was notable however about the rally on Friday was which countries were left behind: France, Italy and Greece.
A common way to measure how investors view a country's financial strength is to compare its government bond yields with those of Germany, which is seen as Europe's safest borrower. The gap between 10-year French and German government bond yields widened from 0.71% at the start of the year to 1.40% by the end of last week, reaching its highest level since the European debt crisis in 2012. This reflects growing investor concerns about France's finances.
While UK government bond yields are higher than those of other G7 countries, a more meaningful comparison adjusts for differences in interest rates and currency costs. On this basis, 10-year French government bonds currently yield 6.51%, compared with 5.37% for UK gilts, meaning investors receive around 1.14% more to hold French debt (sterling hedged) than UK debt.
French equities are also struggling this year having fallen 5.9% while global equities have risen 14.3%, all in GBP terms.
Earlier during September, France officially missed its 2026 budget deficit target of 5% with the shortfall coming in at 5.4% of GDP – sluggish growth was a key factor. France's 2027 budget aims to reduce the deficit to 5%, but doing so would require significant austerity.
The political gridlock makes any budgetary progress difficult; France is on its fifth prime minister in two years. With a split government France has been effectively unable to pass fiscal plans. The 2026 budget was rolled over from 2025 and forced through via a constitutional mechanism without a parliamentary vote after cross-party talks repeatedly failed.
The French are set to go to the polls in May 2027 meaning there is very little incentive for opposition parties to support painful and unpopular austerity measures. France’s 2029 deficit target of 3.0% looks particularly quixotic in this context and the bond market has shown no hesitation in pricing this in.
There is some speculation that the European Central Bank (ECB) will step in to support the French bond market (and possibly the other struggling peripheral countries, Greece and Italy) however the conditionality of such intervention currently requires fiscal compliance with EU rules, with which France is in violation.
France also suffers from a relatively low level of domestic ownership of its bond market which while it may point to a structural weakness could also contribute to a solution if policies are put in place to encourage greater domestic investment.
France should be a warning signal to UK Prime Minister Andy Burnham of the risks of deferring difficult decisions. Labour have the opportunity afforded by a majority to put a multi-year fiscal path in place. Second, the UK should look to incentivise domestic ownership of UK assets, France’s low domestic ownership of OATs has created structural vulnerabilities and amplified the selloff. Third, Burnham’s plans to soften the triple lock (where state pensions rise annually by the highest of either 2.5%, inflation or wage growth) is the kind of decision that French policy makers have not been able to make and that the bond market will reward. The move to a double lock of 2.5% or inflation is a step in the right direction, the case for going further is strong.
There are signs that the UK is on the wrong side of the Laffer curve (a point where raising taxes further can reduce the amount of tax the government collects), yet any reductions in the tax burden seem unlikely. It is probable that for the years ahead higher taxation will remain the principal tool for balancing the books. That makes fiscal credibility elsewhere even more important. The lesson from France is that difficult fiscal decisions do not become easier by delaying them. Eventually, the bond market will force your hand.
The week ahead
US trade balance: The trade deficit is expected to have widened through August from US$88.6bn to US$102.3bn. This would be the widest since imports were front loaded ahead of the ‘Liberation Day’ tariff announcement in March 2025. While industrial supplies are anticipated to have boosted imports, exports have likely increased as the US has increased exports of oil and refined products.
Central bank minutes: Minutes from the ECB and US Federal Reserve (Fed) meetings are due this week. Amidst the global bond bear market central banks are becoming more hawkish but the ECB will be cautious given the limited signs that higher energy prices are feeding through into broader inflation. The Fed meeting was notably more hawkish however the meeting predated the weaker jobs report and soft PCE inflation report from last week complicating the picture. Altogether both central banks are expected to hike once further this year with that hike expected at the December meetings.
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