Tag Archives: Catalonia

Day of Reckoning – Catalonia Part 2

Discussion and Analysis by Charles Porter:

 

This afternoon, the culmination of the Catalonian independence vote may arrive. We analyse the implications within currency markets, predominantly the Euro. In doing so, we offer you an insight into the likely performance of the Euro when it is potentially confronted by a declaration for Catalonian secession later this afternoon.

 

Evidently, Spain has long given up the Peseta, therefore, the effect of the Catalonian referendum upon exchange rates will be localised within the Euro. Given that the single currency brings about de facto insurance to a national idiosyncratic risk (c.f. Mundell 1973), it is possible that the Euro will show relative ambivalence to any possible announcement at around 5pm BST today. The price behind the Euro is still derived primarily from the supply and demand for the currency, however, the understanding behind the value of a currency union must be based upon its cross-border nature. In effect, while the Catalonian referendum might credibly be of national significance, on the Eurozone grand stage, any national effect resembles only a regional shock.

 

The effect within Spanish bonds and equities has certainly been felt. Bonds, for example, are paying a higher yield, reflecting the risk and uncertainty that a Catalonian secession from Spain would create. However, overwhelmingly, these national indicators and markets have managed to remain calm and price the risk modestly. Equities of banks exposed to Spain and Catalonia have been more volatile. These banks have even felt it necessary to insure against a Catalonian secession by insuring their ability to physically relocate and, in the meantime, by adapting their legal headquarters.

 

Whilst our analysis of Carles Puigdemont highlighted his infatuation and belief in Catalonian independence, the constraints that the region’s President faces may precipitate a more moderated response during his speech this afternoon. If the actions taken by Puigdemont are moderate, meaning anything short of a declaration of independence, then I expect a comparable calm within international markets.

 

If Puigdemont pursues a democratic (or bureaucratic/diplomatic) and conversational approach then the risk that is priced into the market reflecting the uncertainty surrounding the Spanish and Catalonian economies will be partially priced out – allowing the Euro and affected Stocks and Bonds to appreciate. Open democracy, conversation and mutual agreement lead to more gradual, predictable, and stable processes, rewarding bonds, equities and assets tied to both economies with more value. Therefore, the effect upon Catalonian and Spanish equities and bonds will be stabilising; lowering the yield on bonds and raising the price of equities and assets.

 

However, in the more unlikely, yet plausible, scenario where Carles Puigdemont achieves and submits a signed declaration of independence then further risk will be priced into the market. Capital will leave the areas most affected by political risk, namely Catalonia and Spain, as uncertainty deteriorates the investment environment. However, given that neither Catalonia nor Spain operate using their own, unique, currency, it must be considered whether the common currency, the Euro, will feel the damage.

 

Whilst the spill over from Catalonia to Spain is inevitable given the analysis within the preceding article, the significance of Catalonia to the Euro is less certain. Accounting for a little over 2% of total Eurozone GDP, Catalonia is not critical to the output and performance of the Euro, but it is also not negligible. Moreover, the longer-lasting potential spill over effect upon both Spanish and Catalonian GDP, should Catalonia become independent and outside the EU, could be strongly negative, particularly if a tariff barrier to trade becomes effective.

 

The fiscal significance of the Eurozone and European Union is clearly low; the European Budget contributes for expenditure of around only 1% of Eurozone GDP. However, Spain’s net European Budgetary contribution to the EU budget will be distorted and the vacuum must be filled by international compensation, or left to fall. With the prospects for European integration increasing according to the foreign policy and integration stance of French President, Emanuel Macron, political risk and fiscal reshuffling could be damaging and disparaging.

 

Perhaps the most valuable present feature of the European Union is the world’s largest single market; free of barriers to entry and internal tariffs. The population of Catalonia as a percentage of the total population of the single market is around 1.5%. To some extent at least, the strength of the single market will be minorly diminished. However, the practical impact of a reduction in potential trading individuals will be negligible given the replenished prospect for further EU accession and an undervalued Euro, for example against the pound, spurring the competitiveness of the Eurozone.

 

The Euro has shown moderate sensitivity to the progression of the Spanish constitutional challenge posed by Catalonia. Regarding the future, highly moderate strength will be conferred upon the Euro if the diplomatic, gradualised, path is taken. Similarly, if unilateral independence is declared this afternoon, the Euro will suffer immediately, and into the trading day tomorrow.

 

 

Although moderately shrugged off by the Euro, the end of trading day spike showing Euro weakness is likely to signal a sell off of Euros before the weekend Catalonian referendum on October 1st. This afternoon’s announcement should prove to be more market sensitive, particularly if the status quo is broken and Puigdemont claims Catalonian independence.

Day of Reckoning – Catalonia Part 1

Discussion and Analysis by Charles Porter:

 

This afternoon, the culmination of the Catalonian independence vote may arrive. We analyse the implications within currency markets, predominantly the Euro. In doing so, we offer you an insight into the likely performance of the Euro when it is potentially confronted by a declaration for Catalonian secession later this afternoon.

 

While Carles Puigdemont, Catalan President, prepares to address the Catalonian parliament, the tension inside the Spanish political economy is mounting. Following the now 10-day-old referendum on Sunday 1st October, Puigdemont feels he is vested with a mandate to declare the secession of his municipality from Spain.

 

The uncertainty and conflict that surrounded the initial referendum should impact markets because it signals the propensity for riots and conflict to ensue in response to developments. When Puigdemont addresses parliament, there is an acute risk that the political composition of Spain, including Catalonia, is exposed. What’s more, underlying tensions that are exposed will likely realise their propensity to generate further conflict. Amidst the uncertainty surrounding the extent of devolved powers, particularly policing, pragmatic and responsible public actions cannot be taken for granted.

 

The Spanish Prime Minister, Mariano Rajoy, has vociferously displayed his unwillingness for Catalonia to leave Spain. Members of the incumbent Spanish ruling party have displayed uncompromising stances towards the Catalonian establishment and public displaying empathy or active support for secession. For example, threats to arrest political public office holders seem credible and are generating concern. It is therefore plausible that convoluted instructions will cause irresponsible public law enforcement, thereby escalating the tension between the nation and the region.

 

So Why is Spain such a Big Deal?

 

There are several reasons why Catalonia is pivotal to Spain and, therefore, why Spain is unwilling to allow the nation to secede. These include, but are not limited to, cultural, geographical, economic, and political. Despite a popular desire for secession, the contentious nature of the debate and referendum indicate that many individuals want to remain a part of the Spanish nation and European Union member state. This is likely to be because, ultimately, despite whatever the future holds for both Spain and Catalonia, they have shared an intricate history. The cultural and social ties across the potential border would inevitably be severed.

 

Geographically, Catalonia occupies much of the affluent border with France. With the Pyrenees creating an impasse across much of the border, the corner access point within Catalonia is critical. The potential to lose an area of strategic geographical significance, both in terms of trade and individual utility, is threatening for Spain. The political will for the nation to remain ultimately harks back to a realist defence of safety in numbers and solidarity with neighbours. The potential divorce of Catalonia from Spain would upset the current status quo of fiscal obligations and arrangements, threatening to stagnate politics and remove critical offices.

 

Evidently, economic reasoning is argued to be the most salient factor motivating the exaggerated market responses. Representing around 20% of the GDP of Spain with over 7.5 million inhabitants, the significance of Catalonia, from their fiscal contribution to their purchasing capacity, is a highly valuable national economic attribute. The attractions within Catalonia, not least Barcelona, draw high volumes of tourists each year, bringing a boost to the economy of Spain and the surrounding areas.

 

In part two of this article, we analyse why the Catalonian question is important to the Euro and foreign exchange markets:

Catalonia and the Euro:

Discussion and Analysis by Charles Porter:

 

It is indisputable that this weekend’s referendum in Catalonia generates considerable headline risk within Europe. The instability, uncertainty, and political risk within the Spanish economy has reflected within nationally sensitive equities and indicators. However, the purchasing power of the Euro, its exchange rate vis-à-vis other currencies, appears to be largely unaffected. The question of whether this relates to a systemic insulation of the Euro, or pure insignificance of the referendum, has a particular importance to those exposed in the Euro.

 

Opening down against the Pound and the US Dollar, the Catalonian independence referendum might have been supposed to undermine Eurozone solidarity. After all, should the independence of the region be declared, at least the form of the future Spanish and potential Catalonian membership with the Union and single currency should be questioned. However, the significance of the difference before and after this weekend’s referendum was only marginal. Interestingly, the weakness within the Euro against the Pound Sterling has been reversed throughout the morning, up to 10:00 BST.

 

The result attested to following the controversial referendum generates a considerable mandate for the region’s independence. The threat of a high-productivity and nationally significant region declaring formal independence from Spain creates uncertainty both within the nation and within the region. The uncertainty should be supposed to deter investors from both the region and the nation whilst the taxation revenue and spending distribution is re-evaluated and the future legal political framework of the independent region understood.

 

This uncertainty has been reflected within Spanish markets. Notably, yields within 10-year Spanish Government bonds has increased by nearly 5% since the close of markets on Friday. The yield on bonds and general debt reflects the inverse of the price of the bond. The yield is the effective return that the bond will pay to the investor and holder of the contract, qualified by its face value. It is clear, therefore, that if the return on a bond increases, it must reflect the risk of holding the contract; the risk of no repayment. Therefore, the increase in the yield of Spanish Government bonds is telling of the political uncertainty and credit-worthiness that the referendum has installed.

 

The spill over from the referendum was not contained within the sovereign debt market. Spanish equities, particularly banking stocks, were hit by the weekend’s events. The violence and reported atmosphere within Catalonia this weekend should be considered as a strong and concerning phenomenon that has exacerbated the scare within financial markets. Overall, the impact of the referendum has damaged the value surrounding the Spanish economy.

 

So, why has the Euro not been hit that hard?

 

Well it is possible that the exchange rate priced in the political risk of the foreseen referendum better than the bond market has. However, this is highly implausible given the transparency and comparability of the free markets of bonds and flexible exchange rates, not to mention their entwinement. Therefore, instead, I suggest that the solidarity within the single currency insulates the single currency from the idiosyncrasies of national concerns.

 

Naturally, a union of 19 national currencies should not be as responsive as a national currency to an upside or downside event affecting only one nation. Sharing a currency shares exchange rate risk, de facto, without explicit design; a currency union is effectively a fixed exchange rate. Therefore, because the Catalonian risk is unlikely to transmit across borders, at least in the medium run, the deserved foreign purchasing parity of the other 18 economies should, ceteris paribus, be intact. Ultimately, currencies are a conduit for which to facilitate international trade, mobility and engagement. As such they are an excellent indicator of the integrity and strength of an economy. Therefore, the risk that the Catalonian referendum generates is mediated and diversified across the other 18 nations, thereby preserving the value of the Euro.

 

For the risk averse individual purchasing international currencies, this suggests that the volatility of the Euro to political agendas should be limited. It could be thought, and has been proven to be so, that the US Dollar contains a similar stability and value. This is why these currencies are used, or increasingly used, as reserve currencies; conduits and mediums to preserve wealth as well as facilitate trade. For those seeking exchange rate upside and downside risk, the Euro and Dollar may be unsatisfactory currencies.