Draghi's QE Buys Some Time for Spain After Election Stalemate

  • Spread over bunds widened just six basis points since vote
  • Political stalemate lingers as Socialists rebuff Rajoy

The sound of bickering among Spanish politicians is being drowned out by Mario Draghi, at least when it comes to the bond market.

Spain’s election on Dec. 20 ended a four-year majority for Prime Minister Mariano Rajoy and left a deadlock over who will form the next government as parliament reconvenes this week. The European Central Bank’s bond purchase program, known as quantitative easing, is buying politicians time as they argue over who should run the euro region’s fourth-biggest economy. The yield on 10-year bonds compared with German bunds has risen just six basis points since the vote.

“Spanish politics are not really driving the bond market for the time being,” said Mark Dowding, who helps manage about $60 billion as a partner at BlueBay Asset Management LLP in London. Bonds “should not be materially impacted when the greater backdrop is ultra-low euro-zone bond yields and QE purchases from the ECB.”

European bonds are being insulated from the type of selloff that characterized the continent’s debt crisis when investors reacted to every political twist and turn and borrowing costs jumped towards unsustainable levels. Spain’s impasse follows one next door in Portugal as parties that traditionally traded power are undermined by jaded voters pining for change, while the market hardly flinches.

Lisbon Spread

Portugal had to appoint two prime ministers in the seven weeks following an Oct. 4 election, which left neither of the two main parties with a majority in parliament. During that time, the spread between 10-year government bonds and bunds widened 22 basis points as the ECB spends 60 billion euros ($65 billion) a month buying up debt.

The yield on 10-year bonds was 1.74 percent for Spain on Monday, while in Portugal they were 2.62 percent. Spain still pays less than the U.K., where the economy is growing at a similar pace and an election last May produced a clear winner.

If investors perceive there’s a risk of a government that would reverse labor and banking reforms and increase public spending, borrowing costs will rise, said Luis de Guindos, economy minister under Rajoy. “There’s not the slightest doubt that this will have an effect on financing costs,” he told Cope radio on Monday.

Spanish Labyrinth

Spanish party leaders are exploring ways out of their political labyrinth as the nation emerges from austerity into a new stage of strong growth. Rajoy’s People’s Party gained the most seats in parliament, but not enough for a majority. The prospects of a left-wing coalition to challenge him also look fraught with difficulty.

Rajoy, 60, has called on the Socialists and the pro-market Ciudadanos party to join him in a broad coalition to shut out anti-austerity group Podemos and protect economic growth and provide stability. The Socialists have repeatedly rebuffed him rather than risk alienating supporters and turning Podemos into the main party of the left.

The deadlock means new elections are becoming more likely and the market will probably start taking more account of that risk, said Marco Brancolini, a London-based analyst at Royal Bank of Scotland Group Plc.

“We have closed all the trades in Spain because we think it is poised to under-perform as as soon as the market realizes that new elections are very likely,” he said. “The market never likes elections.”

Catalan Question

Adding to the uncertainty is the situation in Catalonia, where a new pro-independence government took office on Sunday.

Catalonia represents about 20 percent of Spanish output, and the revenue raised from the 7.5 million Catalans is critical to the Spanish state’s ability to fund schools and hospitals, pay pensions and service its debt. Podemos is the only major party in favor of granting the Catalans a vote on independence.

For now, the relative calm created by the ECB’s stimulus program gives Spain time to resolve its politics and keep the economy on track, said Ruben Segura-Cayuela, a London-based economist at Bank of America Merrill Lynch.

“QE should be enough to assuage market concerns about political paralysis, but once it is gone we would be more concerned without further progress,” he said. “It seems like new elections are becoming increasingly likely and other scenarios such as a grand coalition or a pact led by Socialists and Podemos remain difficult politically.”

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