Even chief financial alchemist Draghi is unable to prevent gravity from taking hold.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
After a summer of missed opportunities, poisoned rhetoric and bitter recrimination, Spain faces what promises to be a very tumultuous autumn.
On September 27 its largest economic region, Catalonia, will hold its most important elections since Spain’s late dictator Francisco Franco passed away 40 years ago. If the pro-independence parties win a majority of seats in Catalonia’s parliament, they have pledged to declare unilateral independence from Spain.
As if that were not enough, in December the country will hold what could turn out to be its most tightly fought general election in decades.
ECB at a Loss
The inevitable result is increased fear and uncertainty – two things that financial markets generally abhor. It’s already beginning to show in the performance of Spanish bond yields. Indeed, as Bloomberg reports, the political instability gripping the nation is having such an effect on investor sentiment that even Europe’s chief financial alchemist Mario Draghi is unable to prevent gravity from taking hold:
Even signals from ECB President Mario Draghi last week that asset purchases could be extended if Europe’s economic and inflation outlook continues to deteriorate haven’t stopped Spanish bonds diverging from Italy’s.
“These moves have some more to run in the coming months, as elections approach,” said Jan von Gerich, chief strategist at Nordea Bank AB in Helsinki. “The main opposition parties are campaigning for a reversal of the earlier reforms. Forming a government will be very hard.”
In other words, the same thing that happened in Greece after Syriza’s victory at the beginning of this year is now beginning to happen in Spain: the nation’s debt is becoming more costly as jittery investors desperately look for other places to park their cash, at least until tensions die down.
One of the biggest beneficiaries so far has been Italy, whose 10-year bonds yesterday widened the spread on their Spanish counterparts to 25 basis points, the highest premium since August 2013 on a closing-price basis.
This represents a fairly significant shift given that at the end of 2014 Spanish 10-year bonds were 28 points lower than their Italian equivalents and even as recently as mid-July Spanish yields were below Italy’s. According to Nordea’s von Gerich, the yield gap may widen further, to 50 basis points, if campaigning gets more heated and the polls get closer.
Even Portugal’s bonds have fared better than Spain’s in recent days, despite the fact that it, too, has fractious elections coming. As for Spain’s risk premium – the spread between the 10-year Spanish government bond, and the benchmark 10-year German bond (bund) – it has widened from 107 to 139 basic points since the end of 2014 and is now back above the long-term average.
Even Spain’s benchmark index, the IBEX 35, is down 17% from its QE-supported perch in mid-April.
A Whole New World of Pain
Despite the gathering economic fallout, political tensions in Spain continue to grow. A new poll showed that pro-independence candidates are on course for a majority in Catalonia’s regional parliament before a Catalan election on September 27. In his latest declaration the region’s premier Artur Mas announced the creation of between 50,000 and 70,000 new civil service positions – whatever it takes to “cover Catalonia’s new state structures.”
It didn’t take long for Madrid to hit back, this time with a barely veiled threat from the Ministry of Defense that a military intervention in Spain’s north-eastern province would not be needed “as long as everybody fulfils their duties.”
Not exactly comforting. Indeed, concerns about escalating tensions between the central and regional government prompted Catalonia’s largest business association, Fomento de Trabajo, to write an open letter detailing what they see as the risks of secession, including being left out of both the EU and the euro as well as not being able to access financing from the ECB.
But even Catalonia’s business community is riven by divisions on the issue of independence. While many of its biggest companies support Fomento de Trabajo’s opposition to Catalonia’s separation from Spain, many smaller companies have come out in support of independence. They include 13 of the region’s chambers of commerce.
Three Long Months Ahead
The markets are not just worried about the dangers posed by Catalonian independence and the prospect of a potentially MAD standoff between Madrid and Barcelona; they are also concerned about the specter of political instability resulting from inconclusive general elections in December.
In other words, at a time when the country’s biggest economic region is threatening to sever the cord, plunging the country into a constitutional crisis of unprecedented dimensions, general elections loom that are likely to return either a desperately weak coalition government or no government at all.
Ironically, if markets continue to vote with their feet by selling Spanish bonds, they could end up achieving the exact opposite of what most market participants actually want – i.e. they could end up fuelling uncertainty rather than ensuring continuity.
Heightened uncertainty and economic weakness at this stage in the game could well backfire. It would almost certainly hammer the final nail in Rajoy’s coffin. After all, the only remotely positive thing that his scandal-tarnished administration has actually done over the last four years is to dig Spain’s crisis-economy out of the proverbial ditch, for now, and at great cost to Spanish taxpayers, businesses, workers, and pensioners.
Rajoy calls it a virtuous circle. But without near-zero interest rates for the foreseeable future, that virtuous circle could very quickly come to a standstill, or revert to a vicious one, especially with global macroeconomic conditions deteriorating and the most important source of Spanish corporate profits, Latin America, on the verge of recession. Read… Europe’s Rising Fear of Upheaval in Spain
By Don Quijones, Raging Bull-Shit.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.