Note three year Portugese paper on Monday…
The yield topped 18 per cent just before pixel-time, with Portuguese sovereign debt generally suffering after the S&P downgrade on Friday.
Portugal has seen worse. As recently as the end of November, this particular flavour of paper spiked out to 19 per cent. And if you go back to last summer, the yield was 21 per cent. It’s a distressed, volatile and illiquid credit at the best of times.
But Monday’s move illustrated a harsh reality: as M&G’s Bond Vigilantes points out, since S&P junked the country (BB with negative outlook), Portugese paper will now be turfed out of the Citi World Government Bond Index at the end of January.
Here’s the relevant bit of the WGBI criteria:
Credit: Any market that falls below BBB-/Baa3 by both S&P and Moody’s will be removed from the next month’s profile and moved to the Additional Market Indexes.
Moody’s already has Portugal on Ba2. (Greece got kicked out way back in July 2010 incidentally)
And that means forced selling by index trackers…
It’s ironic in a way — S&P’s downgrades of the AAA sovereigns hit the headlines, despite the impact on bond indices being minimal. Most of the ones that require AAA ratings wait for at least two agencies to downgrade a single name before it’s kicked out. (Use as collateral might be a different story.) Instead it’s sovereigns on the ratings brink who get this selling pressure. Falling angels or what.
That said, Portugal is so troubled that we were surprised to see any investor still tracking it through an index. (Not to mention, the marketable stock of Portugal’s debt has fallen, etc.)
Probably not the case with (say) Italian inflation-linked bonds. Italian debt is so huge overall that even the linkers number some €120bn or so. Inflation-linked indices usually require tougher ratings than nominal counterparts. So it’s worth noting that S&P cut Italy two notches to BBB+ on Friday…
…and unlike Portuguese bonds, the ECB won’t buy inflation-linked stuff.
Additional reporting by Joseph Cotterill
Dealers call for ECB to buy inflation bonds as Italy faces exit from key index – Risk
The importance of being indexed – FT Alphaville