For Credit Suisse’s Andrew Garthwaite it doesn’t.
He’s fired off an entertaining note to spell out precisely why. And it doesn’t pull any punches.
He starts off by looking at the downgrade from the ECB’s perspective, then picks apart Portugal’s austerity programme and ends by advising clients to remain short the euro and the periphery:
First, it could theoretically matter as the ECB needs a BBB- credit rating to repo Portuguese banks debt – but in the case of Greece the ECB has continued to repo bonds as they were downgraded to junk (and they just lowered their threshold which was initially had an A -, then went to BBB- and then went to “as long as it doesn’t default”). In passing, at Davos last year I heard Trichet say that he would never lower the threshold for repoing Greek Govt Bonds, which he then did within 6 weeks.
Then of course, as we pointed out on Monday, as long as ONE rating agency rates debt at the appropriate level that is all that is required from the ECB’s point of view. Yet, we fully expect Portugal to be downgraded to JUNK status by all not just Moodys.
However, we suspect that even in the case of a Selective Default Greek bonds could be downgraded over the weekend (and S&P have stated that a rollover could be a SD for a ‘short time’ and then the bonds would be upgraded again). So, in effect even into default the ECB could repo. I can smell another U turn.
On Portugal:
Our models say that Portugal needs a 30% haircut to its govt debt (this is higher than most because: a) private sector leverage is 230% of GDP compared to a best-fit line of 150% – and for comparison 160% of GDP in the US and we assume a third of the cost of getting rid of this excess private sector leverage will be imposed on the government and hence government debt to GDP rises to 134% of GDP by 2014 cf 91% at end of this year and b) there has been an absolutely shocking loss of competitiveness. Portugal has a current account deficit of 9% of GDP but has had just 0.5% GDP growth pa over the past decade in spite of the large increase in government spending. Our calculations suggest that wages (which are half of GDP) need to fall 5-10% and that is bad news for GDP. Indeed, we believe that Portugal’s trend rate of growth excluding the government sector is negative and this of course makes the fiscal arithmetic much harder.
We would have been shocked had Portugal not been downgraded to junk and even more shocked if it does not default (although of course we will call it something else). It is only on the face of things that the situation looks less dire than in Greece because the excess leverage is hidden in the private sector whereas in Greece it is in the public sector. The usual smoke and mirrors can smooth the process of adjustment.
And investment conclusions:
Stay short the Euro. One day the market will wake up and realise that repoing €300bn of bonds with peripheral Europe (rising to a lot more, owing to deposit flight) lowers the quality of the ECB balance sheet (surely the domestic collateral is inadequate). Furthermore, we struggle to see how European rates rise as much as the forward curve (june futures for 2012 looking at 3/4% hike from here) when wage growth is just 1.4% and 90% of Spain and Pguese mortgages are floating cf to 20% in Germany· Stay short of peripheral Europe. Markets have not realised in my opinion the degree of wage deflation they need to restore competitiveness.
And on QE for Europe:
My personal view is strongly that the ECB will be forced to repo more and more peripheral European debt as deposit flight accelerates and at some point the ECB is so much on the hook that they have to continue to repo come what may because if they do not the Euro threatens to break up and if the Euro breaks up, there is a 50% default (because peripheral Europe has net foreign debt of 80% of GDP or so) and if the Euro breaks up who would recapitalise the ECB (apart from the ECB by printing!)? I believe one way or another the ECB will end up doing something that we regard as QE.
Related links:
Portuguese covered bonds and collateral damage – FT Alphaville
Greek credit event? Default? Who cares? Danske Bank doesn’t – FT Alphaville