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Spanish Bonds Face Turbulent Weeks on Catalan Standoff, ECB Meet

Spanish Bonds Face Turbulent Weeks on Catalan Standoff, ECB Meet

(Bloomberg) -- Spanish bonds aren’t out the woods yet.

The country’s securities will be vulnerable to political developments, even though Catalan separatists pulled back from an immediate declaration of independence, said Morgan Stanley & Co. International Plc and TD Securities Inc. The debt will also be particularly exposed to any tapering announcement from the European Central Bank this month, Deutsche Bank AG said.

Spanish Bonds Face Turbulent Weeks on Catalan Standoff, ECB Meet

Catalan President Carles Puigdemont has put an independence declaration on hold in order to pursue dialog with the central government in Madrid. The move was met with a strong rebuttal from Prime Minister Mariano Rajoy’s administration, which took the first steps to suspend the region’s parliament, meaning the situation could still deteriorate.

“I’m not sure you’re supposed to be buying Spanish bonds just yet,” Priya Misra, head of global rate strategy at TD Securities, said in an interview with Bloomberg Television. If the regional parliament is suspended, “you get a lot more political risk getting priced in so potentially Spain can still widen out.”

Puigdemont said that an independence declaration would be put off for “weeks.” Such a period could encapsulate the ECB’s next meeting on Oct. 26, when details of its plan to wind down its bond-buying program may be unveiled. While the central bank has bought Spanish debt largely in line with its rules, a high level of foreign ownership means the bonds could be one of the main losers under tapering, according to Deutsche Bank.

Foreign ownership of Spanish bonds has increased since March 2015 -- in contrast to Germany, France or Italy -- making them “particularly vulnerable” to monetary tightening, strategists Jack Di-Lizia and Markus Heider wrote in a note to clients.

Spanish 10-year yields dropped four basis points to 1.65 percent on Wednesday, having retreated from a six-month high of 1.81 percent last week. The spread over their German counterparts narrowed six basis points to 120 basis points, yet could widen again to 150 basis points if the situation worsens, Morgan Stanley said.

Investors will now be paying attention to whether relations between Barcelona and Madrid thaw or grow even more heated.

The situation is “a hard thing to discount because obviously the next stage is the stage of more difficult headlines and more volatility,” said Andrew Sheets, a cross-asset strategist at Morgan Stanley. “What you’re looking at now is some significant uncertainty.”

To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee, Scott Hamilton