By Yoruk Bahceli and Harry Robertson

(Reuters) – President Emmanuel Macron’s shock snap election has rocked France’s bond market, the largest in the euro zone, as a strong showing for the far right and left wing parties in opinion polls exacerbates concerns about fiscal sustainability.

Earlier in June, the risk premium France pays for its debt on top of Germany’s neared levels last seen in 2012, during the euro zone debt crisis.

The question is how much more turmoil the two-round elections on June 30 and July 7 could sow in bond markets.

Here is a look at who holds France’s government debt, key to how markets may react to any further political turmoil:

KINDNESS OF STRANGERS

Foreign investors own around 50% of France’s overall government debt, much higher than around 28% in Italy, 30% in the U.S., 40% in Spain and 45% in Germany, according to data from Barclays and the U.S. Treasury.

Foreign investors “are known to be quite volatile. Whenever there are issues, they get out of the market very, very quickly,” said BofA rates strategist Erjon Satko.

The high share of foreign ownership could mean it takes longer for France’s borrowing costs to settle, Satko added.

French borrowing costs initially jumped after Macron called the election. While markets have settled, the premium over Germany is still more than 20 bps wider than before the election announcement as spending plans from both Marine Le Pen’s far-right National Rally and a left-wing alliance have spooked investors.

Foreign non-bank investors, whether asset managers, pension funds or hedge funds, have been the biggest buyers of French bonds since mid-2022, when the ECB started raising interest rates, Barclays notes.

And hedge funds – speculative investors that bet on price swings – accounted for just over 50% of French government bond trading volumes on electronic platform Tradeweb last year, as they became the dominant players across euro zone government bonds for the first time.

REPEAT OF 2017?

A big focus is Japanese investors – big buyers of foreign bonds, with most of their European holdings in France.

Le Pen’s pledges – now shelved – to pull France out of the European Union and euro rocked markets seven years ago. Ahead of France’s 2017 presidential election, which Le Pen lost to Macron, Japanese investors sold some 26 billion euros ($27.89 billion) of French government bonds – a record – Barclays said.

“There is a potential risk that you have some recurrence of the dynamics that you saw back in 2017,” Barclays rates strategist Max Kitson said.

Last week, Japan’s Norinchukin Bank said it plans sell around 10 trillion yen ($62.6 billion) of U.S. and European government bonds to stem losses from bets that went awry given higher-for-longer overseas interest rates.

Historically high currency hedging costs increase the risk of another round of Japanese selling after stable holdings for 15 months, Citi analysts reckon.

NO DOOM LOOP

French banks own just 7.7% of the country’s debt, according to data from the country’s debt management agency that takes into account fluctuations in the bonds’ prices.

That’s less than the 9.8% recorded in 2014, after which the European Central Bank hoovered up euro zone government debt.

Crucially, their domestic government debt holdings are also low relative to their assets, around 4% at the end of 2023, compared to around 16% in Italy and just under 10% in Spain, according to Deutsche Bank.

“That’s actually an advantage, because you can encourage domestic banks to buy more of the French government bond market if need be,” Swiss Re’s head of macro strategy Patrick Saner said.

It also lessens the risk of government debt ructions spilling over into French banks, Saner added. A bank-sovereign bond “doom loop” was at the heart of the euro zone debt crisis.

That’s good news for French lenders, the biggest three of which have seen their shares fall 9-14% since Macron called the election.

To bring their investments back to pre-2015 levels, euro zone banks overall could buy an additional 616 billion euros of French debt across asset classes, BofA estimated late last year.

Similarly, French insurance companies now hold 9.5% of the country’s debt, down from 19.7% in 2014, according to the French debt management agency data.

BofA’s Satko said there was room for domestic investors to up their holdings of French debt.

“For them it will mostly be about getting the timing right.”

($1 = 0.9322 euros)

(Reporting by Yoruk Bahceli, additional reporting by Harry Robertson and Sara Rossi, graphics by Harry Robertson; editing by Amanda Cooper and Christina Fincher)

---