France’s political deadlock keeps asset recovery at bay By Reuters

By Samuel Indyk and Sruthi Shankar

LONDON (Reuters) – France’s financial assets are stranded as political gridlock and policy paralysis set in, casting a shadow over the outlook for markets and deteriorating public finances.

Investors hoping to cash in on stocks and bonds hit by President Emmanuel Macron’s decision in June to call a snap election could be in for a long wait.

The election produced a hung parliament, and a few weeks later France still only has an interim prime minister. Macron slammed the door on a possible left-wing government despite the left-wing bloc winning the most seats in July’s second-round vote.

Meanwhile, Paris and Brussels remain at loggerheads over France’s worsening fiscal situation, and prolonged political uncertainty and the possible postponement of next year’s budget could set back any market recovery.

“Potentially, you have the ability for French politics to look a bit messy again over the next few months,” said Mark Dowding, chief investment officer at BlueBay Asset Management.

Here’s how French assets are doing and what’s next:

1/ CLOSED IN NOI

France’s weak fiscal position appears to be keeping government bonds on the back foot.

The risk premium, or spread, demanded by holders of French debt over safer German bonds is about 71 basis points (bps). That’s higher than the 50 basis points seen before the election, but down from 85 basis points reached at the end of June – the highest since the eurozone debt crisis more than a decade ago.

A sovereign rating downgrade by S&P in May and a warning from Moody’s (NYSE: ) in July suggest that French borrowing costs will remain relatively high for now.

France’s debt as a share of its gross domestic product is over 100%. Germany is just over 60%.

“We think this is going to be a broader gradual move over time to the extent that we think any movement in spreads will be capped below 100 bps in addition to the presidential election coming up,” BlueBay’s Dowding said, referring -se to French/ German bond gap.

2/ STABILITY, WHERE ARE YOU?

French stocks have underperformed their European peers since Macron’s election announcement on June 9 and an initial post-election rally has fizzled.

A rebound will remain elusive until the political deadlock is broken, analysts said.

The blue chip is 4.6% below levels seen at the start of June, while it is up 2% and Europe as a whole is little changed. French mid-caps, with more exposure to the domestic economy, fell 8%.

“Maybe the markets have underestimated how difficult the political situation is,” said Michael Field, European equity strategist at Morningstar.

“Until we see signs of what a government will look like and, more importantly, whether it’s strong enough to last, it’s probably unlikely we’ll see a rally in stocks.”

Data from Morningstar Direct showed an estimated 243 billion euros ($270 billion) outflow from French stocks and small- and mid-cap funds in June, which failed to recover significantly.

3/ MONEY IN THE BANK

French banks have been hit particularly hard, but for some this is also a buying opportunity.

Societe Generale (OTC: ), BNP Paribas (OTC: ) and Credit Agricole (OTC: ) — the big three French banks — have fallen between 5% and 16% since the June election decision. The European banking index fell by just 0.6% over the same period.

Morningstar’s Field said the international exposure of the big French banks is a buying opportunity. He also warned that prolonged political uncertainty could be damaging, while risks of a growing deficit under a left-wing government could cause funding costs to rise.

“I can certainly see the negatives around the banks, but where there is a disconnect is how exposed some banks are,” he said.

“BNP and SocGen are our favorite plays and they are diversified enough away from this domestic market, their funding being more international, that they can get through this.”

4/ WHAT CRISIS?

The euro, which took a brief hit in June, has bounced back and is untroubled by France’s political troubles.

Earlier this week, it hit a 13-month high against a broadly weak dollar, focusing currency traders on the outlook for interest rates.

The US Federal Reserve is expected to embark on a series of interest rate cuts, with the European Central Bank slowing monetary easing – a positive outcome for the euro. “Political uncertainty could weigh, even with a non-leftist government, but more to limit more euro strength than to trigger a sell-off,” said Roberto Mialich, currency strategist at UniCredit.

(1 USD = 0.9015 euros)