Have a look at the yields on the Portuguese 3-year…
… the widest flavour of paper at the short end of Portugal’s inverted curve, which now looks like this:
The 3-year bond hit 21 per cent on Thursday even as fellow-peripherals as Italy and Spain were tightening considerably.
It’s hard to pin this latest bout of skittishness on anything in particular. There’s the general, obvious worry that after the latest round of euro rating downgrades the bailout firewall will have to be built somewhere east of Lisbon. There was also this report (hat tip TBI) of a powerful Portuguese lobbying group warning of an imminent credit crunch, but we’re not sure how much to make of it.
The FT added some colour in this morning’s paper, remarking on the extent to which Portuguese 5-year yields have differed from those of its peripheral neighbors since the December announcement of the ECB’s 3-year LTROs:
Certainly, the markets are pricing in a Portuguese default with 10-year bonds trading at about 50 per cent of par, a deeply distressed level in the eyes of many investors.
Portugal is also the only peripheral eurozone bond market that has failed to rally since the European Central Bank announced plans to offer three-year loans to the eurozone’s banks on December 8, a move that averted a credit crunch.
Since then, Portuguese five-year yields, which have an inverse relationship to prices, have jumped 268 basis points to euro-era highs of 18.71 per cent. In contrast, the other peripheral nations have seen sharp falls, with Irish yields plunging 265bp to 6.08 per cent, helped by Dublin hitting its fiscal targets and bringing down its budget deficit.
And here’s the inevitable compare and contrast with Greece:
Portugal’s economy is in much better shape than that of Greece, and has a much lower debt burden. Lisbon’s debt to gross domestic product ratio is forecast to rise to 111.8 per cent in 2012 by the International Monetary Fund compared with a level for Athens of 189.1 per cent.
There is also a significant difference between the two countries in market terms. Greek five-year bond yields trade 33.26 percentage points higher than Portugal’s at 51.31 per cent. Athens sovereign CDS is pricing the chance of default in the next five years at 90 per cent, much higher than Portugal’s 68 per cent.
Yet it was only nine months ago that Greek bond yields and CDS prices were at the levels of Portugal today. And at that time, worries over default for Greece jumped sharply as investors and even one of the economic advisers of Angela Merkel, German chancellor, warned that Athens would inevitably need to restructure its debt and end up defaulting.
How acute is Portugal’s position? Here’s the 2012 financing outlook, courtesy of Credit Suisse…
… though it’s probably worth remembering that under the terms of last year’s bailout, Portugal doesn’t need to tap the bond markets until the middle of next year, during which anything can happen, we suppose.
The budget passed by the government for this year is meant to drive the deficit down to 4.5 per cent of GDP (from an estimated 4.7 per cent last year) through a combination of public sector wage cuts and pensions, and a broadening of the tax base.
But an austerity-burdened economy tends to later prove growth projections too optimistic, and the same can be said of what a contracting economy does to deficit forecasts.
Last year the Portuguese economy did better than expected because of surprising export growth, but the surprise was limited to the first half of the year. Credit Suisse reckons it will contract by 2.7 per cent this year after having fallen by 1.3 per cent last year, and that’s assuming no unanticipated shocks:
The worsening of the outlook mainly stems from a very large fiscal retrenchment planned for this year, compounded by a sharp loss of private agents’ confidence. Additionally, exporters could experience more challenging conditions this year and might be unable to match the very good performance of 2011.
It is worth nothing that although external imbalances have started their long overdue correction, the Portuguese current account deficit remains large and requires several more years of deleveraging to put the external debt of the country on asustainable debt reduction path.
Oh, and one more thing to keep in mind:
Additionally, the large number of state-owned enterprises (SOEs) and Public-Private-Partnerships (PPPs) pose a risk of fiscal slippages as they face acute difficulty to roll over their debts from private sources and might have to be reintegrated in the general government perimeter. Also, commercial banks may requiremore funds than earmarked under the EU/IMF programme (€12bn) although the capital shortfall highlighted in the latest stress test only amounts to €7bn.
Portugal faces quarterly reviews of its adjustment program this year by official creditors. The first is scheduled for next month, with the others following in May, August, and November.
Dates to watch — boa sorte.
by Cardiff Garcia and Paul Murphy