Note On Spain: Regions And Banks Compete For Attention

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News that Spain's Catalonia region is seeking support from Madrid provided the headline trigger to the euro's slide and risk-off in North America after a quiet European morning. The euro slipped through the $1.25 level, triggering some stops and optionality only to bounce quickly back, which seems to be frequently the case after barriers are triggered.

The news is a useful reminder of one of our larger points. The flash points in Europe are extend well beyond Greece, which has captured everyone's imagination. Spain problems may be partly exacerbated by the tensions over Greece, but rest assured they are primarily home grown. It also follows that ejecting Greece will not solve Europe's troubles and arguably exacerbate them.
 
The immediate challenge in Spain is turn two-fold: The banks and the regions. The cost of supporting Bankia has risen from 4.5 bln euros to at least 13 bln and the risk is that the eventual cost is greater.

This seemed to be the story of the day, until Catalonia's news hit. This region has the largest amount of short-term debt, with 21 bln euros maturing within two years. It needs to refinance 13 bln this year alone. Catalonia also has the largest deficit among Spain's regional government.

Catalonia is not the only region have funding problems. It was just a week ago that the Rajoy government approved all of the region's 2012 budgets except Asturias, which was given two extra weeks to submit its budget. We argued at the Rajoy government was not seizing upon the opportunity to gain greater control of the region's finances.

The amount of funds that the regions need has steadily risen as older past due obligations are added up. EU staff are expected to be in Madrid next week to get better transparency of what is happening on the regional level, in light of the recent upward revision of last year's national deficit to 8.9% (cf Greece's deficit was 9.1% of its GDP).

While Catalonia's news today overwhelmed the Bankia developments, more negative news on Spanish banks should be expected shortly. Last month, S&P indicated its intention to resolve the negative outlooks on many Spanish banks by the end of May.

The euro bounced by around half a cent after taking out the $1.25 barrier, but it means that next time through there may be a more sustained break. Market positioning and sentiment is stretched, but the headline risk, as today's news from Catalonia indicates, remains on the downside.