Barclays has issued a 'bond vigilante' warning, favoring Germany over France.

• According to Barclays' strategists, German blue-chip stocks are more promising than French blue-chip stocks due to France's weak "long-term fiscal and growth fundamentals" and the risk of bond vigilantes.
• Years of political uncertainty loom for France due to its divided parliament, causing investor concerns about its ability to reduce its debt.
• This week, for the first time on record, French borrowing costs were at the same level as Greece's, indicating the depth of market worries.

According to Barclays' strategists, German blue-chip stocks are more promising than French blue-chip stocks due to France's weak "long-term fiscal and growth fundamentals" and the risk of bond vigilantes.

The two largest economies in the euro zone are facing challenges. Germany is grappling with a persistent manufacturing slowdown that has made it the slowest-growing member of the bloc, while budget disagreements and long-term fiscal planning have led to the collapse of its government.

This year, Germany's borrowing costs have fallen below France's due to political instability in the latter country.

Political uncertainty and debt reduction concerns loom over France due to its divided parliament and lack of majority in any party or faction.

Will French Prime Minister Michel Barnier's government survive the budget proposal in October, which includes substantial public spending cuts and 60 billion euros ($65.6 billion) in tax increases, or will it be defeated in a no-confidence vote prior to its passage?

While a compromise on the French budget is possible, any relief may be short-lived. The political impasse remains, and long-term fiscal and growth fundamentals remain poor. Barclays strategists prefer Frankfurt's stock index over Paris's.

The New Popular Front alliance in France's left wing has stated that they will present a vote of no confidence if Barnier attempts to push through the budget. As a result, the government may have to make concessions to the far-right National Rally party in order to pass the motion.

The Barclays strategists suggested that a potential decrease in the spread between German and French government debt from around 84 basis points to their 70-to-75-basis-point range could boost the CAC stock market index by between 2% and 3%.

If the government falls, the bond spread could widen to 100 basis points and drive the CAC down by between 4% and 5%, and "bond vigilantes would likely step in if no stable government forms or the budget fails to pass."

Bond market investors who disapprove of monetary or fiscal policies can raise borrowing costs for the government by selling bonds, earning them the label "bond vigilantes."

This week, French borrowing costs were equal to Greece's for the first time, indicating that investors now demand the same interest rate for holding French bonds as for historically unstable Greece, which has implemented market-friendly reforms since the debt crisis of the late 2000s.

The French risk premium had already increased before the summer election, causing anxiety about the potential for a far-right or left-wing victory and the resulting populist fiscal policies that may not address debt concerns.

French markets face medium-term risk asymmetry, with concerns about political instability and long-term fiscal trajectory potentially persisting, according to Barclays.

Despite stating that any impact on the euro area would be minimal, Barclays said that any knock-on effect would be limited.

Jane Foley, senior FX strategist at Rabobank, is not convinced.

A worsening in the political and budget outcomes in France could lead to contagion throughout the euro zone, resulting in rising bond yields and a weaker euro, as stated in a note on Thursday.

"The stability of the region's budget and politics affects this risk. Despite Germany's improved debt and deficit position, the country faces significant structural challenges that may necessitate additional government investment. Additionally, a potential snap election in early 2022 could impact whether Germany's debt brake is lifted."

Foley stated that the euro zone is currently experiencing a leadership vacuum in both Germany and France.

— CNBC's Holly Ellyatt contributed to this story.