Friday, 29 September 2017
Catalonia's context within the EU and the Fourth Turning
One of my main passions if you like in finance is the political economy. So the intersection of markets, politics, economics.
I would hardly say that regional debt yielding 2% is 'dislocated' but its more the spread vs Madrid that counts.
Catalonia is one of the richest and most productive parts of Spain (https://www.statista.com/statistics/327120/gdp-per-capita-in-catalonia-spain-and-eurozone/), and similarly, the Basque country in the north near France is rich and has even less cultural similarities to Spain (the Basque language may be derived from an army of Attila the Hun, ie Turks from the Mongolian steppe most of whom eventually settled in modern-day Hungary). If Catalonia gets full fiscal devolution or even independence it will hit Madrid hard which already has 100% debt to GDP. The Basques may also demand a similar deal. The two regions combined are over 40% of Spanish GDP. This would be like the west coast separating from the USA.
I think its hard to predict these outcomes ahead of time and often such important votes are near run things. In fact we have had 'near misses' in the Netherlands, France and Germany this year. So you just have to get out of the way or hedge any existing positions as best you can. Once the dust settles, if Catalonia is cheap vs Madrid, in the end its probably a better credit than Madrid is going forwards.
There is political discord stirring in other parts of the EU and Draghi has successfully papered over the problems from a financial markets standpoint. His policies mean also that problems and dislocations are likely to be localised. France and Germany are probably the only two economies big enough to drive a systemic problem at the moment. Italy has an election next year with three of the four leading parties being Eurosceptic. However one of those is Berlusconi and the likely outcome of the election is a centrist coalition of Renzi and Berlusconi.
I think more generally we are at the turning point of many long run trends. Decentralisation in Europe is one new trend (Brexit, Catalonia, Poland and Hungary refusing some EU edicts). Wage-inflation is another (Trump, Sanders, Corbyn, Le Pen etc). Huge credit super cycles topping out (eg the US credit cycle that started in the mid-1980s), Germany's intra-EU labour arbitrage which has crushed southern European and French industry is seeing some pushback from Macron.
Neil Howe, with respect to his book the Fourth Turning could describe these as classical signs that we are coming towards the end of the third turning, the unravelling of the institutional framework that was set up post-WWII. Howe I believe thinks the Fourth Turning started in 2008, I, on the other hand, think the 3rd Turning started in 1997 and is still underway.
There are many distortions in European fixed income. For example last year I looked at AFL, Agence France Locale. It had a negative yield at the time. Its effectively a 1% equity, 99% debt CDO/ ponzi scheme to finance/ refinance the local municipalities in France who have in many cases taken on CHF and Yen debt and then set up AFL to lower their EUR interest rates. It traded down towards the French election but partially recovered since. Any threat of impairment, ie enough defaults to burn the equity tranche, it will trade off quite a few points. The current yield on it is about 20bps annualised to maturity.