Catalonian catastrophe by ABN AMRO

Marketing Communication

Group Economics

Fixed Income Watch Catalonian catastrophe?

Macro & Financial Markets Research Kim Liu, Aline Schuiling kim.liu@nl.abnamro.com

DISCLAIMER: This report has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead. This report is marketing communication and not investment research and is intended for professional and eligible clients only.

25 September 2015  

On Sunday, regional elections will be held in the Spanish state of Catalonia, … … opinion polls show that support for the pro-independence parties has risen over recent weeks and that they might come close to receiving a majority of the votes, but there still is a gap In case of a pro-independence victory, the road to independence will probably be long and messy The big political test for Spain will be in December, when general elections are due Meanwhile the Spanish economy is flourishing; we expect growth of around 3% over the next year Despite the favourable economic outlook, SPGBs have underperformed significantly this year The underperformance can be accredited to political uncertainty and lack of a domestic bid Although an immediate bounce back is unlikely, we are still supportive of SPGBs in the long run

     

Pro-independence parties have risen in the polls …

polls indicate that the Partido Popular (PP) of PM Rajoy will get

On Sunday 27 September regional elections will be held in the

the most votes (around 30%). However, it will probably not

Spanish region of Catalonia, which accounts for almost 19%

have an absolute majority and will have to be in a coalition,

of Spanish GDP. Recent opinion polls show that an alliance of

possibly with the the more moderate centre-left Citizens (C’s)

pro-independence parties Junts pel Si has risen in the polls

party and one or two smaller parties. Meanwhile, the popularity

and now could get around 41% of the votes. Junts pel Si

of left-wing party Podemos has fallen over recent months, but

consists of parties at the centre-right of the political spectrum

it could receive some extra support from the recent Syriza

as well as parties on the extreme left. Combined with the pro-

victory in Greece. Also, the party no longer is in favour of a

independence party CUP, it could gain around 45-48% of the

euro-exit and has removed some of its most extreme left-wing

votes, but CUP had decided not to join Junts pel Si and its

ideas from its programme, creating the possibility of a coalition

support is, therefore, not certain.

with the socialist PSOE party and one or two smaller parties. Summing up, there seems to be a fair chance that the next

.. but a victory is by no means certain

government will either be a PP-minority government or PP-led

In case the pro-independence parties were to get more than

coalition. In any case, the next government will probably be

50% of the votes, its leaders plan to unilaterally declare

less stable than the current government, implying that political

independence within a year and a half. That said, according to

decision making will be more difficult and slower.

the Spanish constitutional court this act would be illegal. Moreover, the Spanish government will not accept independence and will not work with Catalonia to make it a

Polls general election 2015

happy divorce. Catalonia will probably initially have to leave

% (average eight most recent polls)

both the EU and the eurozone and the way back in could be

difficult and long. Countries such as Belgium, Italy and the UK

will probably hinder a re-entrance as they are confronted with

pro-independence regions within their own borders as well.

These consideration could make people shrink back from

voting for the pro-independence parties when they are in the voting booth, implying that a victory is by no means certain.

10 5

0 Jun-13

Jan-14

Jan-15

Real political test in December

People's Party

Socialist Workers' Party

The real political test for Spain will be in December (probably

Podemos

Citizens

the 13 or 20 ), when general elections will be held. Recent

Insights.abnamro.nl/en

Source: Various polling institutions

Bloomberg: ABNM

Euro Rates Weekly - Catalonian catastrophe? - 25 September 2015

GDP growth Spain versus eurozone

Political uncertainty has led to underperformance… Despite the Spanish economy strongly outperforming the

% qoq, annualised

eurozone, Spanish government bond yields have

5 4 3 2 1 0 -1 -2 -3 -4

underperformed significantly this year. Compared to Bunds, the Spanish 10y yield spread stands currently at a much wider level than when the ECB’s QE programme was announced and when the actual PSPP purchases started. By itself this is not extraordinary as some other and even higher quality spreads are now also trading wider than earlier this year. For example, the 10y DSL – DBR yield spread traded in single digit 2012

2013

Spain

2014

2015

bps territory in January of this year and is currently trading at

Eurozone

almost 20bps.

Source: Thomson Reuters Datastream

However, more remarkable is the underperformance of SPGBs compared to their Italian counterparts (BTPs). From a

Economy flourishes

fundamental economic point of view, the Spanish economy

Meanwhile, the Spanish economy is growing vigorously and is

has performed much better than its Italian counterpart. What is

outperforming the eurozone by a wide margin. GDP was up by

more, the Spanish government also had to bite the bullet by

1.% qoq in Q2 (3.1% yoy), up from 0.9% in Q1. Employment is

implementing reforms. This should further support the Spanish

growing solidly (+3.0% yoy in Q2) and the unemployment rate,

government finances and the economy in the future. We would

although still high, has been falling non-stop since the end of

therefore even argue that yields on SPGBs should trade flat or

2013. Spain has gained competitiveness in recent years, due

to the very least much closer to BTPs and eventually below

to a drop in unit labour costs and economic reform measures.

them. Hence, the Spanish underperformance can only be

The country has implemented reforms that have enhanced

attributed to increased political uncertainty, which clouds the

flexibility and efficiency in the labour and product markets and

bare economic fundamentals.

should help improve government finances and economic growth in the longer term. As long as these are not unwound,

Underperformance of 10y SPGBs

Spain’s economy should remain on track for solid growth in the

In bps

coming years. The government’s budget deficit is still above

In bps

200

should fall to below this level in 2017. Government debt is

150

expected to peak at slightly above 100% in 2016-17 and start

100

the EU’s 3% threshold (estimate for this year is 4.2%), but

falling slowly thereafter.

Key figures for Spain’s economy

0 Jan-15

2014

2015

-20 -40 Mar-15

2016

1.4

3.1

-0.2

-0.4

1.3

Unemployment (%)

24.5

22.3

20.1

Current Account (% GDP)

0.6

1.1

1.0

Budget Balance (% GDP)

-5.8

-4.2

-3.3

Government Debt (% GDP)

100

101

Sep-15

Yield spread 10y SPGB - BTP (rhs)

2.9

Inflation

Jul-15

Yield spread 10y SPGB - DBR (lhs)

% changes

GDP

May-15

Source: Bloomberg

… while SPGBs also lack steady bid from domestic banks Another interesting development, which could explain the underperformance of SPGBs, is the weak domestic bid by Spanish banks. According to data compiled by the ECB, Spanish banks are decreasing their SPGBs holdings as a

Forecasts: ABN AMRO Group Economics

percentage of total sovereign bond holdings on their balance sheet. As a percentage to total sovereign positions, the current holdings are the lowest since 2010. Also measured in absolute numbers, the data shows that Spanish banks have decreased

Euro Rates Weekly - Catalonian catastrophe? - 25 September 2015

their holdings in domestic sovereign bonds compared to one

In general, this means that Q4 could continue to be driven by

year ago. This is in contrast to domestic holdings of Italian

political uncertainty, although the strong fundamentals could

banks. Positions of BTPs as a percentage of total sovereign

limit any further widening. In the long run we are still supportive

bonds holdings have also dropped but are still high from a

of Spanish bonds. The fundamental economic outlook is

historical perspective. In addition, when measured in absolute

strongly in favour of SPGBs and we think that relatively benign

numbers, holdings of BTPs by domestic Italian banks have

political outcomes are the most likely scenario. In addition, we

been quite steady throughout the year and are much higher

expect the ECB to announce an expansion of its QE

than levels recorded in 2014.

programme by increasing its monthly purchases before year end. This should support credit spreads and should revive the

BTPs can rely on strong domestic bid

scarcity trade. However, in the meantime the performance of

As % of total sovereign bond holdings

SPGBs can remain volatile and shaky.

100% 90%

80% 70% Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Holdings in SPGBs by domestic banks Holdings in BTPs by Italian banks

Source: ECB, ABN AMRO Group Economics

SPGB holdings by domestic banks have declined In EUR bn

500 400 300 200 100 Jan-12

Jan-13

Jan-14

Jan-15

Holdings of BTPs by domestic banks Holdings of SPGBs by domestic banks

Source: ECB, ABN AMRO Group Economics

Immediate SPGB outperformance unlikely If the Catalonian elections were to result in a Yes to independence, the road to a possible independence will be long and messy. What is more, the big political test is due in December. We therefore think that it is unlikely that following a negative outcome of the Catalonian elections, SPGBs will perform strongly. Although we cannot fully rule out a temporary bounce back vs BTPs, as this spread has widened too much in our view.

Euro Rates Weekly - Catalonian catastrophe? - 25 September 2015

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