Spanish Political Risk: Don’t Get Carried Away

We caution not to overplay the significance of Spain’s local elections – the results add little information to what polls already suggested about the Spanish general election taking place in November or December.
— Nicola Mai
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Spanish Political Risk: Don’t Get Carried Away

Spanish electoral results over the weekend seem to have spooked markets, especially in the periphery, as they reminded investors that populist movements in Europe are not dead and not confined to Greece. In the two days following the election, Spain’s stock market dropped while Italian and Spanish spreads versus German Bunds widened.

Are market participants right to worry? We caution not to overplay the significance of the local elections – the results add little information to what polls already suggested about the Spanish general election taking place in November or December. Establishment parties PP (center-right People’s Party) and PSOE (center-left Socialist Party) gathered approximately 27% and 25% of votes, respectively, a little more than suggested by recent polls. Newly formed centrist party Ciudadanos (Citizens) gathered roughly 7% of votes (versus polls predicting 15%); however, the party presented lists of candidates only in a minority of municipalities. Finally, radical leftist party Podemos (We Can) – which some observers have compared to Greece’s Syriza party – caught the headlines due to the victory of the Barcelona candidate it backed along with a near-victory in Madrid. That said, it’s hard to say Podemos fared better overall than recent polls suggested it would.

The real concern from an investment perspective is whether Spain could elect a radical leftist government in the general election that would resemble Syriza in Greece. The chances of that look very slim: First, according to the polls, Podemos still trails the two establishment parties. Second, unlike the Greek system, the Spanish electoral system does not assign a large majority premium to the winner of an election. This means that Podemos would need to seek an alliance with a moderate party to be in power even in the (unlikely) scenario that it receives the most votes in the next general election.

There is a lot of uncertainty surrounding Spain’s election, but the risks for markets from this event appear to be contained overall. The ongoing economic recovery in the eurozone and the ECB’s asset purchase program are much more important variables for assessing the outlook for peripheral sovereign bonds and European risk assets more broadly. We believe that these markets can continue to benefit from cyclical tailwinds through the remainder of the year.

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