Here’s how Spain’s election could affect the market


• Nicola Mai, PIMCO
• 6/22/2016
• Spanish people are due to vote again on Sunday, six months after the December general election produced an inconclusive result. Though no party looks set to secure an absolute majority, pressure to form a government will be high.
• While polls are largely unchanged, there has been one key innovation since December: The populist leftist party Podemos has joined forces with the communist United Left party. Together they now enjoy the support of 24% of the population. The remaining 76% is split among the center-right People’s Party, or PP, of current caretaker Prime Minister Mariano Rajoy; the new centrist Citizens Party, or Ciudadanos; the Socialists, or PSOE; and a variety of nationalist and independence parties.
• Alliances formed after the election will decide the future government. As things stand, we see two main options: 1) a moderate PP-Citizens coalition, with outside support from the Socialists (most likely) or 2) a left-leaning Socialist-Podemos coalition, with possible outside support from nationalist and independence parties (less likely).
• The Socialists, whose seat count is projected to fall to 81 from 90, look set to be the kingmakers but are likely to find both options unpalatable. Between the two, our best guess is that they will go with the former, producing a market-friendly result.
• This should not be taken for granted, however, as polls across Europe have proved to be far from reliable in the past, and the Socialists’ political calculus is not straightforward. If the left-leaning coalition does prevail, markets are likely to respond unfavorably with yields on Spanish sovereign bonds rising and European risk assets weakening.
• Note, however, that the formation of a government will take some time, and as such, the near-term market impact of the election will most likely be limited. At current levels, Spanish sovereign spreads, which trade at about 140 basis points over Bunds in 10-year maturities, already price in some political uncertainty and will continue to be supported by purchases by the European Central Bank. A larger risk for European assets remains Thursday’s vote on whether Britain will leave the European Union, which would most likely overwhelm any market reaction to the events in Spain.
• We see these as major features of the secular outlook for the region that warrant cautious sizingLooking longer term, Spain and the UK are just aspects of an evolving picture in which political risk is on the rise across Europe. The failures to produce fast-enough growth and concerns over migration flows are fueling a spanish-flag. of European risk in portfolios.
• Read the original article on PIMCO. Copyright 2016. Follow PIMCO on Twitter.

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