Are Catalan independence concerns overblown and what next for GBP

The Ibex has opened higher this morning, suggesting that fears about Catalonia’s secession from Spain, while not unfounded, have moderated in the face of an extremely unclear situation with no timeline as yet decided for when, or if, Catalan gains independence from the rest of Spain.

There are reasons to be sceptical that Catalan can succeed in its quest for independence. Firstly, it’s extremely hard to gain legitimacy as an independent state. The most recent country to be fully recognised as an independent state by the UN was Bangladesh in the 1970’s, even Israel isn’t recognised by all UN members, which highlights the problems Catalonia will likely face if it pursues with its desire to be independent. Secondly, only 2 million Catalan’s actually voted, the rest of the potential voters may have been put off by Sunday’s violence, however, there are nearly 6 million people in Catalonia, thus it may not be that easy to declare independence when less than half of Catalans actually voted. Finally, it is illegal under the Spanish Constitution to break up Spain, so any plan for independence could be a lengthy battle through the courts and may even require a constitutional change.

Why the sell-off in Spanish assets could be short lived

This is why the sell-off in Spanish assets has been fairly moderate so far and we have not experienced the contagion to other countries’ asset prices like we did in the peak of the Eurozone debt crisis. So far the Ibex index has sold off 3%, and although it is below its 200-day moving average the selling pressure has eased on Thursday. This index is obviously at risk from another sell off, particularly if we see further protests and if we see another escalation in violence.

However, we look to the bond market to get a clearer view of how investors’ feel about Spain, and overall we feel that the bond market tells us that concerns about Catalonia are contained. Although Spanish bond spreads with Germany are higher than they are for Portugal and Italy, they remain at extremely low levels when looked at in terms of the last 5 years.  Spanish debt is only trading at 130 basis points above German 10-year debt, well below the 450 basis points it was trading over German debt back in 2012.

Why markets may not react to Catalonia’s continued quest for independence

While we think that the Madrid/ Catalan stand-off over independence is likely to continue, we believe that it’s impact on the markets and on the Spanish economy could be moderate in the short to medium term for two reasons: 1, it is unlikely to lead to contagion to other EU countries, 2, independence, if it is granted, is likely to take an extremely long time to come to fruition, far too long for most investors’ to change their investment decisions at this stage.

Politics trumps the pound once again

The other big story this morning is the pound, it is continuing to sink and is below 1.32. Just a few weeks’ ago it seemed that the BOE’s shift to a more hawkish stance and the 70% chance of a rate hike that is priced in by the interest rate swaps market would be enough to drive sterling back towards 1.40, but alas no, as we mentioned yesterday the Tories prove toxic for the pound once again. The market seems to be ignoring some fairly solid economic data, progress, albeit slow, in the Brexit talks, and a weaker dollar and euro in favour of politics. After Theresa May’s speech at the Tory party conference on Wednesday, there are rumours that she will be asked (forced) to step down by her own party. The prospect of a leaderless UK in the middle of the Brexit process, or even worse, a Prime Minister Boris, are right to unnerve sterling traders.

For those sterling bulls looking for an ounce of hope that the currency can recover, the yield spread with the US is fairly favourable, as you can see below. The drop in the pound looks overblown compared to the UK-US yield spread, which has remained fairly stable and pound supportive since mid-August.

In the next 24 hours, we could see the focus shift to the US and Non-Farm Payrolls, which may ease the pressure on the pound as the market shifts its attention elsewhere.

Chart 1: 

Source: City Index and Bloomberg