Spanish Bonds Increasingly at Risk as Catalonia Shapes Election

  • Risk of political paralysis adds premium, survey shows
  • Dec. 20 general election set to produce fractured parliament

The risk of a political stalemate will drag down Spanish bonds as the country heads into an election with its biggest economic region agitating for independence, according to a poll of banks active in the debt market.

Investors should apply a premium of 25 basis points to the nation’s bonds to account for the risk of a multi-party backed government after next month’s vote, based on the median estimate in a Bloomberg survey of 18 economists conducted between Nov. 6 and Nov. 13. Ten of the analysts said Catalonia’s move to set up a separate state are adding to the pressure on Spanish debt.

With opinion polls showing Prime Minister Mariano Rajoy’s People’s Party may lose about a third of its seats on Dec. 20 while remaining the largest parliamentary group, the risk of legislative gridlock is mounting as Catalan separatists grow bolder. Their battle with officials in Madrid reached new levels of antipathy last week when regional lawmakers in Barcelona declared the start of the secession process.

“As long as the Catalan secession process is ahead of us, on top of the general elections, investors will be cautious,” said Francois Lavier, a Paris-based fund manager at Lazard Freres Gestion, which helps to manage 17 billion euros ($18 billion) of assets including Spanish government and corporate debt. “Spain could and should trade inside Italy, basically, but is under-performing for political risks.”

Spain’s 10-year bonds yielded 20.6 basis points more than comparable Italian securities on Thursday even though Rajoy has engineered a recovery that has seen the Spanish economy growing at twice the pace of the euro region. Four months ago, before the escalation in Catalonia, the yields were the same.

Should political uncertainty extend during 2016, the Spanish treasury would have to pay extra 381 million euros to refinance more than 154 billion euros of bills and bonds maturing next year, according to Bloomberg calculations based on government data as of Oct. 31. Along with unemployment subsidies, debt interest is the biggest expense item in the Spanish central government budget.

Catalan debt is suffering too.

Even though the region is one of the wealthiest in Spain, and a net contributor to national tax system, its debt trades at higher yield than regions subsidized by the central government. Investors demand extra 183.3 basis points to hold Catalonia’s 2020 bonds instead of Andalusia’s, which has the highest unemployment rate of any region in the European Union.

Still, the political saber rattling could be drowned out by the rumble of the European Central Bank’s quantitative-easing program, according to analysts at Royal Bank of Scotland Group Plc. ECB President Mario Draghi has repeatedly said that officials can extend the central bank’s 1.1 trillion-euro ($1.2 trillion) bond-purchase program beyond September 2016 if necessary.

Neighboring Portugal has been in political stalemate since the Oct. 4 election with neither of the two main parties able to form a government. Thanks to QE, the yield on 10-year bonds rose to as much as 2.91 percent on Nov. 9, before coming back down to 2.4 percent on Thursday, close to the 2.3 percent level it was at just before the general election.

Madrid vs. Barcelona

“We recommend to buy Spain against France as any noise from Catalonia over the next three months can be muted by ECB bond purchases and economic fundamentals,” said Marco Brancolini, a London-based analyst at RBS. “Catalonia is a topic that will stay around for the medium and long term so investors should get familiar with.”

In the short run however, Spain’s political leaders will be making their pitch to voters with the Catalan challenge high on their list of concerns. Rajoy’s PP is on track to win between 118 and 122 seats in the 350-strong national parliament, according to a Celeste-Tel poll for The Socialists are headed for 102 to 104 seats with pro-market Ciudadanos on track for 58 to 62.

“The Catalan elections didn’t provide a solution but rather increased the tension,” said Ruben Segura-Cayuela, a London-based economist at Bank of America Merrill Lynch. “The confrontation between Madrid and Barcelona is set to increase over the next month as the electoral campaign is moving ahead so there is room for further under performance for Spanish assets.”

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