US Treasury yields remain elevated, while European bond markets have experienced significant volatility. Rising oil prices have pushed up inflation and expectations of further rate hikes, which had already weighed on European government bonds, and France's high deficit, record issuance plans, and political uncertainty surrounding next year's presidential election have further amplified the pressure, making the country the epicenter of this selloff.

French government bond yields surged sharply last week, with the yield premium of 10-year bonds over equivalent German debt once widening to the highest level since 2011. The bond selloff subsequently spread to Italy, Belgium, Greece and other countries, with some spread changes reaching their largest levels in years. Bond market pressure eased somewhat at one point, but the French-German spread then widened again, indicating that market concerns over fiscal and political risks remain persistent.

France is the second-largest economy in the eurozone, and its position as the epicenter of this bond selloff is related to the combination of its fiscal situation and political uncertainty. The French government announced its budget plan last week, aiming to reduce the fiscal deficit as a share of GDP from 5.4% this year to 5% by 2027. With the presidential election approaching, there is a risk that this plan may not pass parliament, as opposition parties are reluctant to be seen cooperating with the Macron government. If no agreement on the budget can be reached before the end of the year, France may rely on special laws to keep the government running, and the revenue-raising and spending-cut measures in the budget may not be implemented in time, thereby increasing the risk that the deficit exceeds the target.

Meanwhile, to fill its massive budget deficit and refinance a large batch of maturing debt, France plans to issue a record 340 billion euros in net medium- and long-term government bonds in 2027. The enormous financing needs, combined with uncertainty over the fiscal consolidation outlook, have led investors to demand a higher risk premium to hold French government bonds, intensifying the pressure of falling bond prices and rising yields.

In addition to short-term fiscal pressure, France will hold a presidential election next year, which has also raised market concerns about the country's long-term debt. A recent poll showed that far-right candidate Le Pen and far-left candidate Melenchon could enter the second round runoff. Regarding public finances, Le Pen proposed a plan this week to sharply cut the deficit, aiming to bring the deficit ratio below 3% by 2032 at the latest. Melenchon criticized her for seeking approval from speculators, saying her plan would "paralyze the economy and worsen the deficit and debt problems."

Overseas investors are also one of the factors affecting the market. According to calculations, as of July, Japanese investors held an estimated 145 billion US dollars in French bonds. Rising domestic yields in Japan are making Japanese government bonds more attractive, thereby strengthening the incentive for investors to repatriate funds to Japan, potentially further weakening a major source of support for French bonds.

Since last Thursday, fiscal and political risks in France have further amplified pressure on the European bond market, prompting investors to reassess sovereign debt risks in other eurozone countries. Government bonds in Spain, Italy and other countries fell notably. However, German bonds benefited as investors flocked to this traditional safe-haven market, widening the yield spreads of the aforementioned two countries relative to German government bonds to more than 60 basis points and more than 110 basis points, respectively.

French bond market volatility was an important catalyst for widening spreads across multiple European countries, but Spain, Italy, Greece and others themselves have higher debt levels and face their own political or fiscal risks, which also constitute potential bearish factors. After Spain's parliament rejected a housing plan proposed by the government last week, Prime Minister Pedro Sanchez announced this week that early elections would be held on November 29. In addition, to cope with high energy prices, some European countries including Italy and Greece have asked the EU to relax fiscal constraints on member states, which could also inject uncertainty into the market.

Unlike other eurozone countries, pressure on the UK bond market does not mainly come from spillover of French risk. The UK's reliance on energy imports, combined with fragile public finances, makes its bond market particularly vulnerable when the market worries that the central bank will have to raise rates more aggressively to control inflation. The swap market had previously expected the Bank of England to raise rates four more times by the end of next year, which undoubtedly puts pressure on the bond market. Rising yields further increase the government's fiscal burden. UK government data show that the country's debt interest payments are currently one of the government's largest expenditure items, and this figure is expected to continue rising in the coming years. In addition, UK Chancellor of the Exchequer John Healey is preparing to announce his first budget since taking office on October 28, with the market watching how the government will balance promoting economic growth with maintaining fiscal discipline.

Follow-up focus: As European bond spreads previously surged, the sharp decline in the European bond market itself tightened financial conditions, leading traders to begin lowering their expectations for the number of European Central Bank rate hikes. In addition, the market has begun discussing the European Central Bank's "Transmission Protection Instrument" (TPI). This bond purchase program, established in 2022, is intended to "address unreasonable, disorderly market dynamics" and can be activated when there is "unwarranted and disorderly market volatility that poses a serious threat to the transmission of monetary policy in the eurozone," with no pre-set limit on the scale of purchases. This tool has never been used, and at present it is unlikely that the European Central Bank will use it. A European Central Bank Governing Council member said that the monetary policy transmission mechanism is functioning normally and that the central bank currently has no need to use its policy tools to assist France. France's problems are largely self-inflicted, and the country's central bank governor has warned the public not to expect a "miraculous solution" from the European Central Bank.