Market Commentary: France’s national budget deficit not as dangerous as that of the U.S.
How dangerous is France’s negative fiscal balance for the euro? According to the latest forecast from the EU Commission, the deficit in 2025 will amount to 5.6% of nominal GDP, only slightly less than last year’s 5.8%. This is almost twice as large as permitted under the Maastricht criteria of the currency union – and it does not appear that the new government under former Defense Minister Sébastien Lecornu will be able secure a parliamentary majority for the 2026 austerity budget, just as his recently resigned predecessor François Bayrou had failed to do. Lecornu is already the seventh prime minister of the Macron era. Street battles and blockades across the country are the backdrop to the change of government.
France is not Greece but rather the second-largest economy in the euro area, and so at least at first glance it would be harder than during the 2010–2012 crisis to stabilize Europe’s bond markets. Although yields on long-dated French government bonds have been rising significantly for weeks, especially in comparison to German Bunds, there is no sign of panic: the euro exchange rate has also held steady for weeks at around $1.17 – at the beginning of the year it was at $1.03. No one is suggesting that European policy rates should be raised to prevent a depreciation of the euro exchange rate. This time strong words from the ECB (comparable to Mario Draghi’s “whatever it takes” at the time) are not even needed, because the central bank now has the TPI, the Transmission Protection Instrument, which allows unlimited purchases of bonds from countries that come under selling pressure due to unsound public finances. If necessary, the ECB can therefore “print money.” For market participants, it’s a credible threat.
The fact that European bond markets overall are weaker than I had expected until recently is due to the likely sharp increase in military spending, which will drive up budget deficits. Inflation expectations are at 2%, though, and thus right where the ECB wants them. Deflation is currently no longer an issue in Europe, not least because the economy is likely to improve from now on, mainly thanks to the new fiscal stimulus.
Risks for the global economy mostly stem from developments in the United States. According to OECD figures, the fiscal balance there is expected to reach about -8% of GDP in 2026, the result of expansionary fiscal policies and an increasingly weak economy. The labor market has begun to stagnate. Employment has been growing only very slowly for months. At its next meeting on September 17 the Federal Reserve will therefore lower its key interest rate, the Federal Funds Rate, by 25, if not 50 basis points, despite the recent rise in inflation (consumer prices are at 2.9% y/y), to just above or just below 4%. Full employment takes precedence over price stability in U.S. monetary policy (which so far has not hurt the dollar).
U.S. government debt, however, is increasingly becoming a problem. By now, it has surpassed 120% of GDP. The IMF expects 123% this year which is somewhat higher than in France (116%). Dollar interest rates are still trending down, though (10-year Treasuries are around 4%, comparable French bonds at 3.5%), but the huge and ever-rising deficits could mean that debt servicing may soon spin out of control. Since 2023, interest payments have accounted for a larger share of government spending than the military, which means that the room for new projects is shrinking, especially for economic stimulus.
Of course, the Fed also has the option of purchasing government bonds in unlimited quantities and thereby preventing a rise in long-term interest rates. The U.S. government has, de facto, no debt denominated in currencies other than the dollar and thus cannot go bankrupt, but in reality the room for maneuver is limited simply by the fact that the government is by far the world’s largest debtor and should not overdo it. Foreign “creditors” hold net claims against the U.S. of about $25 trillion, including $9 trillion in U.S. government securities alone. If one day they come to the conclusion that both U.S. bonds and equities are overpriced – the former due to uncontrollable inflation and runaway public debt, the latter due to unrealistically optimistic earnings expectations – they could begin to take profits. In the extreme case, such a run on U.S. assets could lead to a global financial crisis. Deflation, mass unemployment, dollar depreciation, and political upheaval might follow.
As is well known, economists like me love such horror scenarios, and as is equally well known, real catastrophes almost never happen: “But where danger is, the saving power grows as well” (Hölderlin). If the warning signals flash loudly enough, experience shows that politicians can reverse course after all. As we saw during the Greek crisis, even extremely unpopular measures can be implemented in a case perceived as an existential risk.
Overall, investors must be prepared for the possibility of major corrections in the markets at any time – a further depreciation of the dollar against the euro (and the yen), losses in equities and real estate, but then they could also expect gains in bonds from solid issuers. Deflation is more likely than a new inflationary spiral. It would also be the end of the gold boom.
About Wermuth Asset Management
Wermuth Asset Management (WAM) is a Family Office which also acts as a BAFIN-regulated investment consultant.
The company specializes in climate impact investments across all asset classes, with a focus on EU “exponential organizations” as defined by Singularity University, i.e., companies which solve a major problem of humanity profitably and can grow exponentially. Through private equity, listed assets, infrastructure and real assets, the company invests through its own funds and third-party funds. WAM adheres to the UN Principles of Responsible Investing (UNPRI) and UN Compact and is a member of the Institutional Investor Group on Climate Change (IIGCC), the Global Impact Investing Network (GIIN) and the Divest-Invest Movement.
Jochen Wermuth founded WAM in 1999. He is a German climate impact investor who served on the steering committee of “Europeans for Divest Invest”. Jochen was on the founding investment committee of Germany’s SWF KENFO from June 2017 until February 2024.
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