Photographer: Pau Barrena/Bloomberg

Spain Adds to Brexit Mix With Another Vote to Bother Bond Market

  • Party leaders fail to forge coalition as deadline looms
  • New election likely to come three days after U.K.referendum

There’s a nervous month looming in the political calendar for European bond investors.

Spain looks set to hold another election on June 26 after King Felipe concluded on Tuesday that no party can piece together a governing majority from the parliament elected in December. The re-run is due to take place just three days after the British decide on whether or not to leave the European Union. In the background, Greece may still be negotiating with creditors.

That means the risk of holding Spanish debt will be increasing just as investors are looking to limit their exposure to market jitters, according to Jose Mosquera, chief investment officer at Madrid-based hedge fund Rho Investments Sil SA. At 1.64 percent, 10-year yields have edged up to their highest in almost six weeks.

“Rather than pay the cost of hedging political uncertainty, many investors may decide to sell beforehand,” said Mosquera, who manages about 60 million euros ($68 million), including the government bonds. “With liquidity likely to be thin ahead of the Brexit vote and Spanish election uncertainty built into secondary prices, we will likely see higher yields on Spanish government debt.”

In the four months since the last election, opposition groups have failed to broker the three-way alliance required to oust Prime Minister Mariano Rajoy.

King Felipe VI held meetings with party leaders through Monday and Tuesday, offering them a final chance to offer a way out of the impasse. Despite a last-minute offer from a regional anti-austerity group, Socialist leader Pedro Sanchez was unable to bridge the ideological chasm between pro-market Ciudadanos and the anti-establishment group Podemos. He needs the support of both groups to win an investiture vote.

Spain has to sell about 221 billion euros of debt this year to pay bonds that are maturing and finance the euro region’s biggest budget deficit. Rajoy has relied on the European Central Bank’s 1.7 trillion-euro asset-purchase program to keep borrowing costs in check.

The ECB’s push to drive euro-area borrowing costs into negative territory means investors are paying the Spanish government to borrow for up to two years. The extra yield on Spain’s 10-year debt compared with Germany’s, though, has increased by about 15 basis points since March as efforts at forging a government ran into the sand.

There’s also a chance Brexit might be no bad thing for Spanish bonds, according to Pau Morilla-Giner, chief investment officer at London & Capital Group. He said that the potential policy response from the rest of the European Union outweighs the risk of Britain voting to leave, currently seen as a 20 percent chance by the Number Cruncher Politics Referendum Forecast.

“In the unlikely case of Brexit happening, Germany would do whatever it’s necessary to keep the European Union together,” said Morilla-Giner, who helps to manage $4 billion of assets. “That would be good news for countries such as Spain.”

Spanish Finances

For now, European officials are demanding more budget cuts after Spain’s efforts to get its deficit under control were blown off-course by last year’s election. As the country heads for six months without a full government, the pace of economic growth is slowing and separatists in Catalonia still agitate for independence.

Even a fresh election may not offer a clear way out of the impasse -- polls suggest the result in June may differ little from the verdict voters offered last year.

“We think Spanish assets are likely to underperform,” Barclays Plc analysts Apolline Menut and Antonio Garcia Pascual wrote in a note to clients this month. “Especially if U.K. exit risk persists.”

Before it's here, it's on the Bloomberg Terminal.