We suspect the markets is underestimating the risk involved with the Catalonia independence movements. EURUSD 1 month implied volatility continue to decline despite potential event risk. Markets generally price the most obviously path of events. Hence why markets always get caught flat-footed by extreme events. Depending on what media you chose to watch will significantly influence your view of the situation. Over the weekend, demonstrations in Barcelona against independence helped lessen uncertainty. While threats of migration of large corporations out of Barcelona convince capitalist thinkers that logic and “common” sense would find a markets friendly resolution.
Pundits suggested momentum had sifted to moderate independent groups. However, we should use Noble prizewinner Richard Thaler’s work in behavioral economies dealing with “irrationally” to guide us. Or we can just remember how a similar corporate-line mislead most investors on Brexit. No, after Spain and Europe recent actions we suspect that Catalonia’s have harden their resolve for independence. The separates have been extremely quick since Monday that would hint as to coming strategy. Yet Madrid raise the stakes as Spain’s Deputy Prime Minister, Soraya Saenz de Santamaria, announced in a press release that the Spanish government s would trigger article 155 if Puigdemont declares independence. A move widely expect but one drew a clear line in the sand. Pushed in a corner, in our view the separatist only next move will be the declarations of independence most likely today. Madrid would trigger Art 155 of the constitution which dissolved key Catalonia powers and allow the central government to take control. The article has never been activated and guide lines are gray.
Yet the move will be seen as a clear escalation. What come next in our view is extremely unclear. Yet we are not ready to concede an orderly solution that requires constitutional changes and reliance of ratification by two-thirds of the Spanish parliament. The act of declaring independence would indicated that the movement no longer considers Spain legitimate and unlikely to continue through traditional constitutional process. In the near term we remain short EUR and see current EURUSD rally to 1.1780 as an opportunity to reload short position.
By Peter Rosenstreich