“Today sees the start of a new political era,” Podemos leader Pablo Iglesias told supporters gathered in Madrid after Sunday’s largely inconclusive elections [10] in Spain. “The forces of change are making a historic advance.”
Iglesias is certainly correct that things have changed. Spain’s three-decade old political duopoly was toppled over the weekend with PP and PSOE garnering their lowest combined share of the vote since the eighties.
Iglesias’ Podemos - the anti-austerity party that many equate with Syriza - polled stronger than expected, winning 69 seats in Parliament and 21% of the vote. Here’s a look at the results compared to projections:
[11]
Needless to say, this is bad news for Brussels and bad news for markets (at least in the short-term). The fragmented outcome means the coalition building process will be arduous to say the least and that means the process will be plagued with uncertainty. The worst possible scenario from Berlin’s perspective would be for Spain to go the way of Portugal - that is, with a left-of-center alliance moving to topple the PM. Admittedly that outcome looks less than likely here, but as Deutsche Bank puts it, “there is no obvious solution” in terms of forming a stable government. Here’s a look at several possible coalitions:
[12]
Below, find some commentary from sellside desks that underscores just how convoluted the situation has become followed by some additional color from our end.
* * *
From Deutsche Bank
1) A PP and PSOE grand coalition: numerically strong, politically unlikely
A grand coalition would have a large majority (213 seats). However, such a grand coalition would be unprecedented in Spain. We can draw a comparison with Greece rather than Germany. Politically, but not economically, there are several similarities. After the dictatorship Greece was dominated by two parties, the centre-right New Democracy and centre-left PASOK from 1977 to 2012. But since 2011 PASOK suffered the emergency of radical-left SYRIZA as the country battled through the debt crisis. In the June 2012 general election, PASOK won just 12.3% of the votes versus 43.9% in 2009. The government alliance with centre-right New Democracy further damaged the centre-left party. Last September PASOK obtained just 6.3% of the votes.
We think PSOE will keep in mind what happened to the centre-left in Greece. Their incentive in formation a coalition with PP would be to avoid a new election given the recent positive momentum of Podemos. A change of leadership in PSOE could also bring a less confrontational relationship between the two traditional Spanish parties. Still, we think that via such a coalition the PSOE would run a greater risk of losing further votes than returning to elections in the short term. Hence, a PP-PSOE coalition could become feasible only when the other options are exhausted. Were a grand coalition to be formed, the two parties would struggle to agree on material structural reforms.
2) A Citizens-PSOE-Podemos “alliance”
In theory, a Citizens-PSOE-Podemos coalition would have a large majority. That said, such a coalition would probably damage Citizens as its electorate comes largely from previous centre-right voters. Indeed, after the May regional election support for Citizens in polls temporarily dropped. We think this was due to a disappointment of centre-right voters who either abstained or switched from the PP to Citizens but then saw the left gaining control of several local governments.
Even if we are wrong, we do not think that such a heterogeneous coalition would be stable. We are also concerned that the government would struggle to successfully tackle Spain’s challenges of lowering unemployment while reducing the large net external debt. While, we do not see Citizens supporting policies such as a reversal of the labour market reform, the three parties could target a material slowdown in the fiscal consolidation, with significant risk of fiscal slippage.
3) Stalemate and a second general election
There no obvious solution in our view. This is why we think that a second election around March 2016 is as likely as any of the above two alternatives. Indeed, we do not feel that we have enough elements to conclude which of three alternatives – grand-coalition, a tripartite agreement or a new election – is the most likely. That said, even if a new government is formed we doubt it would last the full legislature. An early election in the short or medium term seems the most likely outcome. Still a new round of election would not necessarily guarantee a solution.
* * *
From UBS
The provisional overnight result from the Spanish parliamentary elections suggests that Partido Popular, led by Mr. Rajoy, has won the election with 123 seats (29% of the vote). However, the number of seats is not sufficient in the 350-member parliament to form a majority government – not even with the support of Ciudadanos, the newly- formed centrist party, which has secured 40 seats (14% of the vote). A potential alliance between PSOE and Podemos, including the regional parties (ERC…), may afford the larger majority, which may form the new government.
The outcome is highly uncertain
The new parliament will be formed on 14 January 2016 and will have up to two months to elect the new government. Negotiations will be necessary since PSOE and Podemos would need the support of the local regional parties to form a government. Ciudadanos has stated recently that it would not support the other minority parties. A “German style” coalition PP-PSOE is possible but seems unlikely as there are no precedents. Therefore, at the moment, a coalition between PSOE, Podemos and the regional parties seems the most likely outcome to us but could be somewhat unstable.
Instability not discounted; possible retreat on reforms, less budget control
With the election outcome unexpected relative to the latest polls and despite the possibility of the formation of a stable government in the future, we think this scenario is not fully discounted by the market. Consequently, we expect debt and equity markets to react unfavourably. The near-term bond market reaction is likely to consist of a widening of 10-year yield spreads by as much as 30bp or more. However, we would view this as a likely buying opportunity over the medium/long term.
* * *
From Goldman
In our preview of the elections, we expected a minority (centre-right) PP government that gained support from the centrist Ciudadanos party. While PP gained the expected level of support, Ciudadanos gained less support than we had expected. Taken together the two parties fall significantly short of a majority (163 versus 176 required). While the PP will try to form a government first and there are other right-of-centre parties in Congress these are regional nationalist parties. For historical reasons, these parties are by no means natural allies of the PP. Mr Rajoy has acknowledged that forming a stable government will not be easy.
Relative to most polls and our own views, Podemos exceeded expectations and Ciudadanos fell short. The two established parties did broadly as expected. But the surprises in terms of Podemos and Ciudadanos change the arithmetic of the parliament quite significantly.
The most feasible coalitions are insufficient to deliver a majority
We do not believe a 'grand coalition' of the centre-right PP and centre-left PSOE is likely. Ahead of the election, Ciudadanos also indicated that it would find it difficult to form a coalition with Podemos. It is possible that some of that resistance changes after the election - especially one that leaves the country struggling to form a government. Yet we continue to believe these outcomes are unlikely to deliver a stable coalition.
A coalition between PSOE and Podemos has already emerged in some municipalities. They share anti-austerity views and are opposed to market-oriented reforms, although earlier momentum behind these in Spain had already waned ahead of the election. Yet these two parties will require further support from several other regional parties, including those on the right of centre, to deliver a majority. Regional nationalist parties, including those on the right of centre, are more natural allies of PSOE and Podemos than of the PP with PSOE and Podemos is more inclined to grant additional powers to the regions. Given these changes, it is worth recalling that politics in Spain remains strongly pro-European and yesterday's election result has not changed that.
Overall, we conclude that reaching a coalition agreement will be difficult since it will require parties with significantly different political views to set those aside. Any coalition seems prone to instability as and when it needs to respond to unforeseen events. This raises the likelihood of repeat elections, although these cannot be held within two months of yesterday's election.
* * *
From Barclays
The bottom line is that there is no obvious alliance that would add up to the 176 seats needed for an absolute majority in the 350-seat Parliament.
A PP-PSOE alliance is highly unlikely based on the statements by the leaders of the two largest parties.
PP and Ciudadanos would get 163 seats, and PSOE and Ciudadanos would get 130.
PSOE and Podemos would get 159 seats.
Ciudadanos has ruled out joining Podemos in any multi-party alliance.
As for the rest of the parties, practically all are nationalist parties from either Catalonia or the Basque Country, which makes them unlikely coalition partners for either PP or PSOE:
ERC: 9 MPs (Catalonia, leftist party, pro-independence).
DL: 8 MPs (Catalonia, conservative party, pro-independence).
PNV: 6 MPs (Basque Country, conservative)
IU: 2 MPs (radical-left party).
Bildu: 2 MPs (Basque Country, radical -left, pro-independence).
CCA: 1 MP (Canary Islands).
What are the next steps?
1. The new parliament will be formed on 13 January 2016.
2. PP will get the first chance to form a government and will submit its proposal to a vote by the parliament. If it does not get an absolute majority of MPs (at least 176 MPs), which seems highly likely, then two days later there would be a second vote where a simple majority would suffice. If PP fails to win support, then PSOE would get the opportunity to form government, following a similar procedure to the one described above.
3. Following the first vote in parliament, the government approval process cannot take more than two months. If no government is approved within two months, the parliament would be dissolved and new elections would need to be held.
* * *
Meanwhile, as political analysts struggle to predict what comes next, the market has already rendered its judgement. Spanish 10s and 30s opened sharply lower as yields spiked 11 and 10 bps, respectively. SPGBs subsequently recovered, but the message is clear: the market, as always, hates uncertainty and this is a highly uncertain situation.
For their part, JP Morgan recommends you stay short Spanish 5s versus Italian govies and Danske is out with a similar call. Additionally, it's worth noting that ECB QE pauses tomorrow and won't resume until January, which could put more pressure on EU government debt (of course if Podemos were to end up holding sway over Spanish politics, PSPP purchases of SPGBs might just end up "pausing" permanently [13]).
Above we said that the nightmare scenario for Brussels and Berlin would be for a left-of-center coalition to topple the Rajoy government. While that would be decidedly bad for pro-austerity eurocrats there's actually a worse outcome: a second election that sees Podemos win outright. On that note, we'll close with the following from Pablo Iglesias:
"Neither actively or passively will Podemos allow the People’s Party to govern. We'd be well placed if new elections held."
