We continued to see an underpricing of Catalonia risk. Partially since markets tend to expect the least intrusive outcome and partially the market rumours that this is merely a domestic issue. Meaning should Spain break up, the EU will deal with both parties as separate entities. This is fake news and massive miscalculation.
The European Commission issued a statement, which indicated should Catalonia ever leave Spain in a legal referendum; it would immediately be thrown-out of the EU. In a massive error, the callousness of the EU government by siding with Madrid, despite the brutality on referendum Sunday, is likely to make Catalonia’s loyalty to the EU weaken. In our view the strongest argument for Catalonia to remain a part of Spain, a unified Europe, has now been squandered. Removing this logical argument opens up this struggle to extremes.
The regional government of Catalonia has issued general demonstrations for today, which is likely to harden both sides rather than relieve tensions. Empowered by the lack of consideration for the democratic process radical members of the Catalonian government have called for unilateral declarations of immediate independence. The outlook for Span has gotten considerably more uncertain.
Our expectation is for a call for independence this week and the possibility of triggering Article 155, where the Madrid government would take over regional policy and fiscal tasks. We remain bearish on the euro in light of events in Spain and expect things to get worse before they improve. Break of 5-month uptrend at 1.1836 indicate bearish extension to 1.1660 August low.