Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman
Spain has been caught in the cross hairs of the market since Prime Minister Rajoy unilaterally announced a relaxation of its fiscal target this year, after missing the target for the last couple of years. He effectively delivered a fait accommpli to the EC and a compromise was reached. Spanish bond have been under pressure with 10-year yield flirting with 6% in recent days before recovering yesterday and today.
There are three developments in Spain that might not yet been appreciated by investors.
First, the EU’s economic team is set to visit Spain today and tomorrow. This is not related to the 2012 budget issue, but has apparently been planned for some time. The EU cannot be happy with Spain, though it gave preliminary support for the 2012 budget. There is no doubt Spain is in a recession and it is not clear where aggregate demand is going to come from. Households and the government are deleveraging, while exports are flagging.
One of the issues that the EU is still waiting for details are the regional budgets. The regional governments have a great deal of autonomy but also responsibility especially for education and health care. The Spanish parliament is today agreeing to give the central government greater ability to intervene in the regions that fail to reach their budget targets.
Just like euro zone countries are sacrificing some of their fiscal sovereignty to preserve the union, so too will Spain’s regional governments find their autonomy more limited. In fact, in some regional governments, there is greater debate about transferring responsibility for health care and education back to the central government.
Lastly, Interior Minister Diaz announced a “reform” yesterday aimed a limiting the use of social networking as a means to curb what appears to be a rising wave of protests and social unrest. The law is not only aimed at those instigating violent protests, but also attempts to disrupt public services, such as transportation.
We note that despite the firmer tone to Spanish bonds, the equity market not participating in the broader rally and the financial sector is the hardest hit, following Fitch’s assessment that the funding pressure on Spanish banks is unlikely to ease soon. And despite the modest decline in yields, the CDS remains near its recent highs. We continue to expect the news stream to be negative for Spain.
Next week features another bond auction, amid assessments that Spanish banks, the large buyers of Spanish sovereign bonds, are becoming satiated. Also Spain reports its housing price index for Q1. It has fallen every quarter since Q1 08. In Q4 11, house prices fell 1.5%. The risk is for faster decline. Spain’s Feb trade balance (deficit) will be reported in the middle of next week. Spanish exports were strong the Aug-Nov ’11 period, but slowed markedly in the Dec-Jan period.