Euro Politics and Rates: Spain’s new left-wing government has big plans but little fire power – Following Spain’s general election on 10 November, a left-wing government took office on 13 January. The new Sánchez II government is a minority coalition government of the social democratic PSOE led by Prime Minister Pedro Sánchez and the left-wing populist Unidos Podemos led by Pablo Iglesias, who has been appointed as one of four deputy prime ministers. The coalition holds 155 of the total 350 seats in parliament, implying that it needs the support from other parties or groups for its policy initiatives. Indeed, during the investiture vote, the government only got a minimal majority of the votes thanks to the abstention in the vote of two Catalan and Basque independence parties.
The programme of the new government holds a number of significant policy changes. For instance, it plans to raise the minimum wage, make some changes to the pension system, hike taxes paid by large companies and high-income earners and unwind some earlier labour market reforms that had limited job protection. Still, implementing these policy changes seems very difficult. To begin with, the new government would need the support of two or more parties in opposition to get any policy change approved by parliament. Moreover, the government’s hands are tied by the fact that it has to apply to the constitutional rule that its structural budget balance needs to be close to zero, whereas it currently is close to -3%. Finally, Spain’s economy has lost momentum and growth is expected to slow down from 2.0% in 2019 to 1.3% in 2020, which will weigh on government finances. All in all, the problems that the government will probably face when it tries to implement its policy plans suggest that this government (again) will not serve its full term.
Overall though, we think that the effects of Spanish politics on structural economic and fiscal policy will prove to be rather limited. Political fragmentation is resulting in a relatively weak government and the most likely outcome is policy stagnation. That means governments will be unable to implement constructive policies but it will also limit any harm they can do from an economic and fiscal perspective. Taken from this angle, Spain’s government bonds seem to have discounted too much bad news. They have underperformed their Italian and Portuguese peers since the election and also since the government formation. In addition, a comparison between sovereign spreads and credit ratings shows that Spain’s spread is too high relative to its current average rating. In addition, we maintain the view that the ECB will step up its monetary stimulus in the coming months and Spain’s government bonds should be one of the main beneficiaries. Our 3m target for the 10y Spain-Germany spread is 50bp. (Aline Schuiling & Nick Kounis)
US Macro: Downside risks to inflation building – Core CPI inflation came in below expectations at 0.1% mom in December (ABN AMRO/consensus: 0.2%), with annual inflation stable and in line with expectations at 2.3% yoy (2.26% unrounded). The print suggests a continued lack of inflationary pressure, with recent weakness even in more typically stable supports for inflation such as shelter (i.e. housing rents). Indeed, momentum in this component has declined dramatically over the past year, from a peak of 4.2% 3m/3m in May, to just 2.3% in December – the lowest since March 2013. Pipeline pressures also continue to weaken. The big story from last Friday’s payrolls for us was the undershoot in wage growth, with annual wage growth falling below 3% for the first time since mid-2018. And one little-discussed consequence of the Phase One trade deal with China is that with some of the rollback in tariffs, the upward pressure on core goods that we saw at times in 2018-19 is likely to unwind again in 2020. All of this points to downside risks to inflation this year, and combined with our expectation for a further weakening in growth in the US, this supports our expectation for a further rate cut from the Fed in H1. (Bill Diviney)