Wednesday, September 26, 2012

Markets spooked by Catalonia's push for independence

IG CDX spread has widened sharply in the last couple of days as the corporate CDS index has become the choice to hedge against global macro risks. It is liquid and provides portfolio managers with a cheap option.

IG CDX (Bloomberg)

And of course the latest macro risks are percolating in the Eurozone once more. Analysts are looking at Spanish debt as a measure of rising risk premia in the Eurozone, but it is the wrong indicator. In spite of Spain's yields rising this morning, they no longer represent the actual stress in the area, given the ECB's potential ability to "manipulate" them. IG CDX and other liquid credit indices are far more indicative.

Spain is again at the epicenter of the renewed volatility. Rajoy is desperately trying to "front-load" the austerity measures in Spain so that they look "internally imposed" rather than a result of the bailout by the ECB - which is coming. But time is running out as tensions in Spain escalate. The anti-austerity protests in Spain  - some have been bloody - are making headlines. Of course when over half the nation's young people are out of work, that's to be expected.

A much larger issue rattling the markets has to do with Spain's regions (as discussed back in March). BBC has a good overview of each of the regions and the problems they face (here). The central government is in the process of bailing them out via a fund set up recently (see discussion). Andalucia is now considering asking for a €4.9bn from the Spanish central government, making it the fourth region to be bailed out after Catalonia, Valencia and Murcia.

What really spooked the markets however is the talk of Catalonia's push for independence. The region's government is broke and has asked for a €5bn bailout. Given its wealth relative to other regions however, people there feel they are carrying a disproportionate burden in taxes. And just as the tensions in the Eurozone often revolve around the disparity between the wealthy and the poor states, the same dynamics are at work among the regions in Spain (a bit like northern vs. southern Italy).
Reuters: - The government's drive to rein in regional overspending as part of its austerity measures has prompted a flare-up in independence fervour in Catalonia, the wealthy northeastern region that generates one-fifth of Spain's economic output.

Just as the euro zone crisis has strained relations between wealthier nations of the north and heavily indebted countries to the south, Spain's crisis has aggravated tensions between the central government and its self-governing regions.

Catalonia is broke and needs a 5 billion euros bailout from the central state to meet debt payments this year, but Catalans are convinced they bear an unfairly large share of the country's tax burden.

More than half say they want independence from Spain, the highest level ever.
What market participants are beginning to realize is that Catalonia's independence could push Spain out of the Eurozone - no matter what the ECB does. The region's economy is critical to Spain and the Spanish government desperately needs the tax revenue from Catalonia. The government's budget target for 2012 looks untenable as is. Without Catalonia, the Spanish economy and Spanish government finances would simply collapse.
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