Beware The Spanish Boomerang

The new year’s cheer is proving infectious, with global equity markets off to a flying start as the big macro risks which stalked the global economy in 2012 – the eurozone crisis, US fiscal cliff, and Chinese slowdown – have been addressed (at least for now).

Although we see good reason to subscribe to the 2013 ‘good news’ optimism, we add one major caveat: Spain. While US politicians can continue kicking the can down the road, and the Chinese authorities have an unrivalled ability to mobilise resources and squeeze more juice out of their mercantilist investment growth model, Spain cannot be so easily turned around. A gaping hole in the state’s coffers, a deep recession, destructively high and rising unemployment, and an inability to engineer immediate currency devaluation, all give cause for concern.

However, there still seems to be a lot of good faith going around. The market has faith in the European Central Bank (ECB)’s Outright Monetary Transactions (OMTs), the ECB has faith that Spain will enter a structural macroeconomic adjustment programme, and the Spanish government has faith in its ability to avoid an official bailout.

This is dangerous thinking.

As we have argued previously, the collapse in peripheral eurozone sovereign bond yields after the OMT facility was unveiled on September 6, 2012 has provided the Spanish government with a false sense of hope that it can avoid taking the contentious decision of negotiating a bailout. As long as the market pressure is off their shoulders, the Spanish government will continue to drag its feet. However, with the economic data flow poor and potentially deteriorating further this year, positive investor sentiment could dissipate quickly and the market could once again ratchet up the pressure on the government.

As such, we warn that once the current euphoria dies down and investors once again take stock of global risks, Spain will likely be the first target to pop up on the radar. Market turbulence could come back with a vengeance.

Further analysis of Spain’s debt dynamics, fiscal problems, and the eurozone crisis is available to subscribers at Business Monitor Online.