‘A Fly In The Ointment’ But Nothing To Worry About, Apparently…

Well, it’s safe to say the Catalan referendum did not go “smoothly.”

Those who predicted things would escalate and ultimately spiral completely out of control were largely vindicated on Sunday. Spain’s constitutional court had of course already declared the poll illegal and the government had committed to disrupting the proceedings, so it’s hard to see why anyone inclined to vote “no” would have any incentive whatsoever to show up. That, in turn, raises practical questions about why even go through with this in the first place. I recognize that sounds insensitive and it certainly doesn’t say much for the long-term viability of a government when that government has to literally resort to force to suppress a separatist movement. But again, from a purely practical perspective, this makes little sense.

That said, from a symbolic perspective it’s obviously important and if you’re a separatist, you undoubtedly felt compelled to use this historic opportunity to express your support for the idea that people have an inherent right to self-determination. If the government steps in to forcibly prevent you from expressing that support, well again, that doesn’t say much for the government and the optics around said violent suppression are horrible. Case in point:

Here’s a summary of Sunday’s most important geopolitical event courtesy of The Guardian….

Via The Guardian

• According to the Catalan health ministry, 465 people have been injured as Catalans vote in an “illegal” referendum on the region’s independence. The two most seriously injured are in hospitals in Barcelona.
• Although advocates stressed the right to political self-determination, the vote was banned by Spain’s constitutional court and millions of ballot papers were confiscated before the vote.
• Local and national authorities say 336 voting centres, of more than 2,000, across the region have been closed by police.
• Voting has been marred by a brutal police crackdown. Videos show police hitting people in the crowd with batons while voters hold up their hands, police dragging voters from polling stations by their hair, and Spanish police attacking Catalan firefighters.
• The police action has been mostly confined to Barcelona, the Catalonian capital. There has been no police presence in the majority of voting stations throughout the region.
• Polls have shown 70% of Catalans want to be able to vote in a referendum but they are more evenly divided when it comes to independence.
• There have been several calls for the Spanish prime minister, Mariano Rajoy, to resign over the police response from Catalan politicians and opposition MPs.
• Human Rights Watch has released a statement calling on Spanish authorities to respect citizens’ right to peaceful assembly and refrain from using excessive force.
• The Labour party has condemned the police violence. Emily Thornberry, the shadow foreign secretary, said: “It is unacceptable for the Spanish authorities to overreact to today’s events through aggressive police action and the forcible closure of polling stations.”
• The European Union is yet to make an official comment.

Again, nothing “fun” about that.

This has (or maybe “should have” is better) implications for asset prices to the extent it is yet another piece of evidence to support the contention that the E.U. is destined to splinter further in some way, shape, or form with the only question after that being how Brussels will react in terms of endeavoring to hold the union together by taking an inclusive approach to newly-drawn borders and freshly-minted nation states or else remaining rigid and watching the entire experiment crash and burn.

So given that, one would expect the euro to come under some degree of pressure in early trading and it might also be reasonable to expect some reaction in equities, but then again, this is a market that doesn’t care about geopolitics. Lurking in the background for the bears (or for anyone who has bets on that would benefit from a resurgence of euro breakup risk) is Mario Draghi, who theoretically can change the rules on PSPP at will on the way to simply printing however much money it takes to keep a lid on periphery spreads (and remember, at this point pretty much any paper that isn’t issued by Germany is “periphery”).

So draw your own conclusions and we’ll take this opportunity to present the following from Barclays who suggests that the Catalan ordeal and pretty much anything else that can be defined as “geopolitical” is nothing more than “a fly in the ointment”…

Via Barclays

Politics and geopolitics: A fly in the ointment, but not more so than usual

Away from the macro outlook and central bank policy, there are several political developments of note in the fourth quarter, including the 19th Chinese communist party Congress in mid-October, a possible showdown in the US government in December, and a separatist referendum in Spain. On the geopolitical front, the North Korean crisis is, of course, the most crucial.

We do not expect drastic changes in the aftermath of the 19th party Congress in China. The macroeconomic and market environments are calm (China posted a strong first half of growth, and the Shanghai Composite index is up over 8% year-to-date), a contrast to some past party conferences. We think President Xi is set to consolidate his power further. Some might worry that the government will rein in credit growth after the Congress is over. But this started a while back; the PboC returned to a tightening bias in August, broad credit growth has been moderating in Q3, and intensifying pollution controls have led to several factory closures. USD weakness across 2017 has also, we think, helped China tighten policy with limited repercussions. We do not expect any sudden policy shift; a moderate slowdown remains our base case.

In the US, a rare bipartisan deal extended the debt ceiling suspension, as well as kept the government open until December 8. This raises investor concerns of a fiscal “cliff” at yearend, especially around the debt limit. But thanks to the suspension of the debt ceiling, the US Treasury will gain access to extraordinary measures of about $300bn, which should push any concerns related to the debt limit at least to March. A government shutdown is still a possibility in December, but such shutdowns have occurred with some regularity and with limited economic effect. We estimate a hit of 0.1pp to annualized GDP per week of shutdown; even a few weeks of closure are unlikely to change the macro outlook. Finally, while progress on a tax cut package has been frustratingly slow, we do not believe it is required for the US economy to grow at its current pace or that tax cuts (as opposed to tax reform, which now seems very unlikely) will materially change the medium-term economic outlook. There is some upside risk to our 2018 US GDP forecast if a tax package is legislated early next year, but any such effect should be temporary.

In Europe, progress on Brexit talks has also been frustratingly slow, but both sides now agree on the need for a transition deal, reducing the risk that the UK crashes out in March 2019. Investors should not be too worried about Catalonia’s independence referendum on October 1; separatist voters are a minority, the Spanish government has not endorsed the referendum, and the constitutional court has deemed it illegal. Political noise could increase in Italy as the electoral law is amended and parties prepare for 2018 elections. But there is also some upside political risk in Europe if Merkel and Macron step up collaboration and take tentative steps towards a reform of the EU that would address the shortcomings that have fed anti-European sentiment, although this could be complicated by the results of the German election.

We would characterize existing political risks as of the run-of-the-mill variety that investors always face and a far cry from the high-stakes political events of the past several quarters (events that markets navigated with aplomb), such as the French elections this spring and the Brexit vote last summer.

The North Korean crisis is more difficult to assess. As we go to press, the rhetoric has grown more heated, and there are media reports that US warplanes are skirting the North Korean coast. But unless actual hostilities break out (we cannot accurately assess the probability of such an occurrence, but assume it unlikely), markets should react relatively calmly to a continued war of words, just as they have so far.