Now that the Spanish province of Catalonia has voted overwhelmingly for independence and the European Commission has confirmed if it does indeed secede from Spain, it will also be leaving the European Union, markets must now come to grips with the possibility of “Catalexit.” By most measures, the exit of Catalonia would be even more catastrophic for the Eurozone than the dreaded "Grexit." While Catalan gross domestic product is $255 billion, Greece's GDP is less at $195 billion.
The question of legality aside, the Spanish government’s decision to respond to the Catalan independence referendum with force has united the province almost completely against Madrid. There appears to be little chance of Catalonia remaining a part of Spain now, at least willingly, short of a bona fide, full-blown civil war with Madrid forcibly invading Barcelona. Such a prospect seems quite horrific, but cannot be ruled out.
As expected, Spanish equities are tanking on the news with videos of Spanish police beating and shooting voters, understandably riling markets. The iShares MSCI Spain Capped ETF (EWP, Financial) was down about 2.3% on the news.
While these are short-term consequences, the longer-term consequences will be determined in the next several weeks. From here, the Catalan parliament is expected to ratify the results of the referendum on Oct. 6, with 90% reportedly in favor of secession from Spain. After Oct. 6 comes Madrid’s reaction. Regardless of what it may be, we could be a looking at a Spanish bond bloodbath and a contagion to the weaker, more indebted eurozone countries.
Catalonia accounts for 21% of Spanish GDP and about 16% of its population. Cut that tax revenue out of Spain’s budget and a spike in Spanish interest rates is likely. If and when Catalonia’s $255 billion annual GDP gets cut out of the national figures, Spain's debt to GDP ratio will skyrocket and attention will shift once again to Italy, Greece, Portugal and Ireland, the weakest and most indebted of Eurozone countries.
So far, the European Commission is staying out of the issue and is hinting the vote was illegitimate, and the reason is clear. The EU has a vested interest in keeping Barcelona and Madrid together because it knows the dangers a divided Iberian peninsula would mean for the eurozone and the EU. They know Catalexit would be mathematically more serious than Grexit, aside from the fact the power centers of the EU are still reeling from Brexit, which is still in the midst of being negotiated.
No matter which way you slice it, the most vulnerable asset class in Europe as the Catalonia wound festers will be sovereign European bonds, particularly those of the weaker more indebted countries, and especially Spain’s at the epicenter.
Disclosure: No positions.
