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Why Spain is the Biggest Risk for Europe


Posted: Tuesday, September 29th, 2020

Estimated Reading Time: 3 minutes

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Ever since the 2008-2009 Great Financial Crisis and the 2012 sovereign crisis in Europe, the Spanish economy struggled. Not that before 2008 it outperformed, but it was always Italy the sick child in the South, not Spain. Naturally, we exclude Greece from this discussion.

When financial markets smell blood, like they did during the Greek crisis, the yields will trade higher on the European countries perceived as the weakest ones. In 2012, it started with Greece, but the panic quickly spread to Spain, Italy, Portugal, and even core countries.

The coronavirus pandemic brought an abrupt reality check for the Spanish economy. Already weak and with slow growth in the periods prior to the pandemic, it now faces the risk of having to deal with higher yields than BTPs (Italian government securities) sooner rather than later.

Spanish Yields

High Youth Unemployment and Tourism Dependent Economy

Fast forward four years after the 2012 sovereign crisis, and the SPGBs (Spanish Government Bonds) started to yield below the Italian counterparts. While the Spanish government engaged in a labor market reform, the Italians lagged.

After Christine Lagarde took the top job at the European Central Bank (ECB), one of her mistakes was to declare in a press conference that the ECB is not here to close the spreads. Whenever the risk was/still is measured in Europe, the BTPs are the benchmark.

But the SPGBs yields will likely trade higher as a result of a tourism-dependent economy and high youth unemployment.

Spain has less than 5% of its population migrating to the neighboring countries or further. After the 2008-2009 Great Financial Crisis, the younger generation used to flee to the United Kingdom in search of a job. The rest remained in Spain heavily engaged in the tourism industry.

The pandemic took the tourism revenues away, while Brexit closed some doors to the Spaniards looking for a job abroad. Unemployment levels, already elevated before the pandemic, reached over 40% for the younger generation. These people are in Spain, have nothing to do, and will have a hard time finding a job the longer the pandemic holds.

In this crisis, the Italians look more united, while the Spanish government cannot even agree on a budget.

Commercial Credit Continues to Shrink

Spanish commercial credit fails to improve despite a gradual economic reopening. It just shows that the coronavirus impact on the economy is likely to stay longer than many have anticipated. 2020 erased the last five years of commercial credit growth, revealing a hard time ahead for the Spanish economy.

Spain Consumer Credit

With a few exceptions, all economies around the world are on life support. When it comes to developed economies, there is no precedent for the amount of stimulus (monetary and fiscal) seen in the last six months.

Spanish yields are kept low thanks to the ECB policy. But at the first sign of trouble for the ECB (e.g., deflation), the market will push pressure on Euro area members.

Nowadays, Italian BTPs are the norm for measuring the risk in Europe. Even the EURUSD exchange rate trades in a close correlation with the Italian yields.

But judging on how Spain fared this crisis so far, the risk is that the SPGBs will quickly become the new benchmark for European risk.

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