The Crisis in Spain: Why Are Markets So Calm?
Catalonia’s bid for independence has held Spanish assets back rather than being outright damaging
By Richard Barley
FALLING BEHIND
Performance of stock indexes
Earlier in 2017, investors were obsessed with political risk in Europe. Today, Spain faces a profound constitutional crisis over the push for independence in Catalonia, yet markets don’t seem particularly bothered. Can that be right?
The Spanish standoff differs from recent bouts of eurozone political stress that passed swiftly.
Spanish Prime Minister Mariano Rajoy has asked for the power to remove the Catalan government and call fresh elections. Catalan separatists have called for civil disobedience in response to the prospect of control from Madrid. No quick resolution appears imminent.
However, the worst that can be said for markets is that Spanish stocks are lagging a strong rally. The Euro Stoxx index has gained 5% since the start of September, while the IBEX 35 is down 1%. The yield spread between Spanish and German 10-year bond yields has remained steady, at just under 1.2 percentage points, while the euro has barely reacted at all.
What explains this? Importantly, the Spanish constitutional clash isn’t about Europe or the euro; that limits any wider fallout, particularly for the currency. Growth across the continent is strong and Spain has been particularly impressive, growing at a 3% annualized pace, which gives comfort to investors. While Catalonia accounts for close to one-fifth of the Spanish economy, the effects of the Spanish crisis haven’t shown up in economic data yet. The purchasing managers’ indexes due early in November should be watched for any sign the economy is taking a hit.
As for the bond market, investors’ attention is probably mainly on the European Central Bank meeting this week, where policy makers are expected to scale back the pace of bond purchases while extending them into 2018. Spain’s relatively higher yields, plus the ECB purchases, make the country’s bonds hard to pass up.
More broadly, investors have learned in 2017 that it has paid to remain invested despite political risk in Europe. That may not be the right strategy because Spain’s protracted crisis differs from scheduled elections in the Netherlands and France, where the risks were easier to assess.
While it isn’t easy to see how Madrid and Catalonia can resolve their differences, neither is it clear what the path would be for Catalonia to achieve independence—something that would likely cause severe economic disruption. For now, that tension limits movements both up and down in markets. But with Spain in uncharted constitutional waters, bonds and stocks of other eurozone countries may offer safer harbors.
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