Catalonia referendum: 'Worst case scenario' escalates Madrid-Barcelona showdown – Sell Bonos, Ibex

Spain: Worst case scenario from Catalonia referendum point to heightened Madrid-Barcelona showdown, likely independence call – Sell Bonos vs Bunds, Ibex (esp. Catalonia corps eg Caixa Bank)

• Strategy implications: Results and press coverage from Sunday’s referendum are pointing towards the worst-case scenario (written about in our Week Ahead): Increased showdown between Madrid and Barcelona – with either govt unlikely to reverse course/change tact anytime soon. The two central and regional govts share key weaknesses – they’re both: 1/ Unstable (minority-led), 2/ Can’t be seen by their constituents/political partners to relent and 3/ Both believe they can unilaterally impose their will on the other (Madrid by royal constitution and Barcelona by popular democracy). And these commonalities help to explain the currently intractable situation as well as the developments over the last 1-2mths that led up to this showdown. Trade ideas:

  • Fixed Income: Spain Bono-Bund spreads are likely to continue its rise towards pre-French election wides (150bp vs Monday open: 120bp).

  • Equity: Shorting Ibex is likely to (finally) prove profitable after frustrating (and premature) shorts over the past month. Expect Catalonia-based corporates to underperform – including CABK. Although Caixa Bank has underperformed the Ibex over the past 1mth, it is still an outperformer ytd (+30% vs benchmark: +9%, vs 19% Santander).

  • EUR: Developments will add to a modest short-term bearish EUR bias already weighed by lack of a Germany coalition-building (until Lower Saxony elections next week) and USD upside from US tax reform reflation this week (see Week Ahead).

Visuals: Spain Bono-Bund spreads and Ibex - 5yr and 2017 ytd (Bloomberg, 2 Oct-17)

• What’s new?: The Sunday referendum was going to be a ‘numbers game’ and by two key metrics – turnout (2.3m out of 5m eligible) and victory margin (90% “Yes”) – it was a resounding victory for Catalan leaders who had expressed comfort with declaring independence on just 1.8m votes (‘gracias’ or ‘gràcies’ Madrid, whose interference may have inadvertently upped the symbolic "Yes" votes and probably kept Catalan 'remainers' away from polling stations).

  • Spain PM Rajoy seemed out of touch when on Sunday night, he praised police for their “calmness” in defending the constitution. As polling stations prepared to open at 9am, police in riot gear smashed doors and dragged protesters, beating some with batons and firing rubber bullets at others. Puigdemont described the crackdown as an “unjustified, excessive and irresponsible use of violence.”

• What’s next?: The large victory margin coupled with a Catalan leadership promise to respect the vote suggests that Pres. Puigdemont is likely to move forward with an independence declaration by Friday, 6 Oct. This is a significant day to call for independence as it marks exactly 83 years since the same 1934 proclamation by Catalan martyr Lluis Companys (Wiki) during Francisco Franco’s dictatorship.

  • Madrid is likely to continue to attempt to delegitimize the process – though if the perceived heavy-handed approach (that we’ve seen thus far) continues, this would only risk: 1/ Emboldening Catalans further, 2/ More criticism/blame within PM Rajoy’s govt (watch reaction from Basque Nationalist partners) and 3/ Less sympathy from the international community. If the situation stays protracted, there may be increasing talk of a ‘no confidence’ motion, though opposition parties would need to rally around a rival candidate for that to succeed.

  • Don’t expect the EU to answer Catalan Pres. Puigdemont’s appeals for support – given sensitivities towards regional movements elsewhere (eg Wallonia).

  • Risk to the above baseline scenario is that Catalan leaders are arrested, but this would only delay/not resolve underlying forces. Situation likely to stay uneasy.