The gauge of French bond risk has hit a new milestone as investors brace for potential political turmoil next year and the possibility that a populist government could loosen fiscal constraints.

The extra yield on French 10-year government bonds over safer German bunds has risen above 120 basis points for the first time since 2012.

The spread has climbed sharply in recent weeks, with the latest leg higher coming after French inflation data came in above expectations.

French Bonds Flash Red: Spread Over Germany Breaks 120 Basis Points

Marie Jacot, CEO of Edmond de Rothschild Asset Management France, said this level is a "wake-up call for the bond market."

Investors are nervous about next year's French presidential election, as with only seven months until the vote, opposition parties remain unwilling to compromise with the outgoing Macron government.

According to a voting intention survey published this week, far-right candidate Marine Le Pen and far-left candidate Jean-Luc Melenchon are expected to advance to the second round runoff.

"As Melenchon and Le Pen rise in polls for the second round of the presidential election, the political risk embedded in the spread is further intensifying," said Theophile Legrand, rates strategist at Natixis.

On Wednesday, French bonds underperformed.

The latest inflation data showed French prices accelerated at the fastest pace in more than two years in September, putting more pressure on European Central Bank policymakers.

Traders are betting the ECB will deliver a third rate hike before year-end, with as many as three more possible next year.

"Supply-driven price pressures are squeezing real incomes and economic growth while pushing up interest rates and borrowing costs. This combination makes an already difficult debt trajectory even harder to stabilize," said Skylar Montgomery Koning, macro strategist.

French fiscal risks also continue to draw attention.

The French debt management agency announced late Tuesday that it plans to issue a record total of 340 billion euros ($386 billion) in medium- and long-term bonds next year (net of buybacks).

The French government will unveil its 2027 budget on Thursday.

With economic growth slowing sharply and a fragmented parliament resisting austerity measures, France has consistently struggled to reverse its runaway public finances.

The fiscal deficit is projected to soar to around 5.4% of economic output in 2026, rather than narrowing slightly from 5.1% in 2025 as the government originally targeted.

Political and Fiscal Concerns Mount, France May Become Europe's "Weakest Link"

Political and fiscal turmoil has caused French bonds to underperform in the recent global selloff.

Over the past four months, the spread between French and German bonds has nearly doubled, with 120 basis points seen as a key psychological threshold.

France's long-term borrowing costs have also risen to their highest level since 2002.

French government bonds are also trading 22 basis points higher than Italian 10-year bonds, the highest level since the eurozone's inception.

This marks a dramatic reversal for the Italian bond market.

In 2018, Italy was heavily sold off by investors after a populist coalition government clashed with the European Commission over spending rules.

"We remain sellers of French government bonds and buyers of German bunds, because things will get worse before they get better," said Kevin Thozet, a member of Carmignac's investment committee. "France is being identified as Europe's weakest link."