Newton Investment Management: Spaanse verkiezingen en obligaties

Apr 25, 2019

By Paul Brain, Head of Fixed Income

Political uncertainty to create short-term instability for Spanish bond spreads

“This month Spain will hold its third general election in less than three and a half years. The polls suggest votes could be split between the existing left/right parties and the new right-wing challenger Vox. Once again it appears unlikely that any party will gain a majority with the probable outcome a coalition government.

“Any coalition would create initial uncertainty for investors until it became clear what parties would be willing to compromise on in order to work together. Ongoing electoral dissatisfaction created two of the newest parties, Unidas Podemos and Ciudadanos, and now Vox are joining the fight. We expect electoral dissatisfaction to continue as a global trend.

“Implications for the bond market could stem from the tendency of populist parties to promise the electorate easier fiscal policies which can lead to higher budget deficits. Additionally, repercussions could also stem from parties’ inability to deliver enough fiscal easing to satisfy elements of the electorate, which subsequently leads to the creation of even more far-left and far-right populist parties.

“The continual increase in the number of parties dilutes the overall vote, which results in coalition governments that have limited ability to effect any meaningful change. This is not just a problem in Spain -  last year’s Italian general election and Emmanuel Macron’s reversal of European Central Bank monetary policy in France both displayed how unsettling this can be for bond investors. The fact that other countries face similar desires to weaken their budgetary stance means Spain should not be too badly penalised by bond investors for any modest fiscal slippage or post-election uncertainty.

“The underlying economic backdrop for Spain remains good (unlike Italy), and this should support bond spreads. Once the election has become old news and we have a functioning coalition, we would expect spreads to stabilise. The demand for any yield pick-up remains strong, especially if the ECB continues with its negative interest-rate policy. This demand, together with the underlying improving credit quality of Spain should gradually see Spanish bonds at a premium over German bunds.”