Spain Election Quandary Tests Sovereign-Bond Investors' Resolve

  • Biggest risk is no party has majority: Societe Generale
  • Peripheral bonds have weathered crisis due to ECB's QE program

It’s an anxious wait for bond markets as Spaniards head to the voting booths on Sunday in general elections that may redefine the nation’s political landscape.

Spanish 10-year government bonds rose for a third day on Friday, pushing yields to a five-day low. That’s an indication investors anticipate a result that maintains policies that have cut budget deficits and trimmed unemployment from one of the highest levels in the developed world, even as the Catalan separatist movement threatens to fracture the country. No party will win a majority in the election, according to most polls.

“There might be some short-term negative market reaction” from most possible outcomes, said Marius Daheim, a senior rates strategist at SEB AB in Frankfurt. “I still believe the risk is that the support for left-leaning parties like Podemos might be higher than what the polls are suggesting right now.”

The nation’s securities were relatively stable as the European Central Bank bought sovereign debt in Spain and across the 19-member bloc after embarking on a stimulus plan in March.

QE helped buffer Portuguese bonds from a selloff in October. That’s when an inconclusive election resulted in the top vote-getter, a conservative, having to step aside to let a minority Socialist government rule, with plans to ease austerity measures.

A majority of the 20 economists surveyed by Bloomberg said that a relatively conservative government made of the ruling People’s Party, led by Prime Minister Mariano Rajoy, and newcomers Ciudadanos, who are frequently described as centrists, would be the best outcome for the economy.

While polls suggest an alliance is possible between these two parties, Albert Rivera, the leader of Ciudadanos, has said he won’t make a pact with Rajoy, clouding the political outlook. Another risk is that anti-austerity party Podemos and the Spanish Socialists could garner more votes than predicted by surveys and force the budget strings to be loosened.

“There probably will be some spread-widening and more volatile development of Spanish yields, but I am cautiously optimistic that this will settle down as soon as the coalition government with Rajoy and Ciudadanos will be formed,” SEB AB’s Daheim said.

Unclear Results

The extra yield investors demanded to hold Spanish 10-year debt compared with similar-maturity Italian bonds has narrowed from 2015’s peak, reached in September, signaling a relative calm in the run-up to the elections. Analysts warn that an unclear result on Dec. 20 and prolonged haggling among parties that didn’t win a majority of votes to form a government could weigh on the nation’s sovereign debt.

“The biggest risk is lack of majority,” said Vincent Chaigneau, the global head of rates and foreign-exchange strategy at Societe Generale SA. “Our economists are quite confident, based on polls, that the most likely outcome is a coalition between the People’s Party and Ciudadanos, which I think will be quite market-friendly.”

Spanish bonds have underperformed Italian ones this year, but Chaigneau “tends to be positive” on them because he sees Spain’s credit credentials as better than those of Italy.

Yields on Spain’s 10-year government bonds climbed seven basis points, or 0.07 percentage point, this week, and were at 1.69 percent as of the 5 p.m. close in London on Friday. The 2.15 percent bond maturing in October 2025 fell 0.645, or 6.45 euros per 1,000-euro ($1,084) face amount, to 104.115.

The securities yield 12 basis points more than similar-maturity Italian debt. The gap was as wide as 28 basis points in mid-September, which was the most since 2013.

Holders of Spanish bonds have earned 1.7 percent so far this year through Dec. 17, while investors in Italy’s debt gained 4.7 percent, according to Bloomberg World Bond Indexes. The average across the euro zone was a 2 percent gain.

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