A Eurozone Crisis Rerun? Watch Spain

Real contagion would require investors to decide that Spain and Italy shared similar vulnerabilities

By Richard Barley



ITALIAN PANIC
Ten-year government bond yields

Source: WSJ Market Data



Is the eurozone crisis back? Italian government bonds have moved even more violently than during 2011-2012. A key question now is how far the ripples spread across the eurozone. Investors should watch Spain.

Spain and Italy once traded places on the front line of the eurozone crisis. Spain was under greater pressure in 2012 when European Central Bank President Mario Draghi’s pledge to do “whatever it takes” turned the tide. 

Spain faces its own political challenge in the shape of a no-confidence vote in the minority government led by Prime Minister Mariano Rajoy. Photo: paul hanna/Reuters 



This time round, Spain’s bonds have only stumbled—the 10-year yield has risen to just over 1.5% from a low below 1.2% in April—while Italy’s have been hammered. The gap between Spanish and Italian 10-year yields has hit levels not seen since 2011; the gap between Spain and Germany, at 1.2 percentage points, was often seen in 2017.

That Spanish bonds get caught up in bouts of risk aversion is a legacy of the crisis: All Southern European government bonds are recognized as containing a mix of credit and interest-rate risk. So some spillover is unavoidable. Real contagion would require investors to decide that Spain and Italy shared similar vulnerabilities.

For now, that looks a stretch. Yes, Spain faces its own political challenge in the shape of a no-confidence vote in the minority government led by Prime Minister Mariano Rajoy, as well as lingering uncertainty over Catalonia. A snap election could jangle nerves. But there is nothing like the uncertainty caused by Italy’s crisis.


SPAIN´S REBOUND
Annual change in gross domestic product

Source: Eurostat


The political climate in Spain is much more pro-European, perhaps because its economy has been growing at a 3% clip in recent years, far above the pace recorded by Italy. Spanish unemployment has also fallen sharply in recent years. Meanwhile, the strong market forces that drove eurozone yields down in recent years are still in play, with the ECB only expected to exit gradually from its monetary stimulus.

During the previous crisis, a lot of eurozone countries looked alike, creating contagion. Now Italy really stands out. The current selloff in Spanish debt looks more like an opportunity than a reason for concern.

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