The ECB’s possible Portugese gambit

Draghi-day is just around the corner and JPM’s Malcom Barr is of the opinion that the ECB might just kick off its move by purchasing short-dated Portuguese sovereign debt.

Heck, why not? The arguments to intervene are simple enough.

Portugal is actually doing rather well and is exporting its way out of trouble at a reasonable tick (even though its largest trading partner is… well… Spain).

From Credit Suisse via Sober Look:

… the performance of Portugal is all the more impressive considering its strong economic linkages with its neighbour, Spain. This is really the key risk for Portugal going forward. Indeed, the success of its adjustment relies on the speed at which it adjusts its growth model toward a more export-driven one. The weaker its trade partners, the slower the adjustment.

As Barr notes, the market for Portuguese short term debt is relatively small – there are some €24bn of conventional 1-3 year bonds outstanding not in ECB hands – so relatively modest purchase volumes could have a big impact on yields.

And says Barr:

A demonstration of what ECB bond market support actually meant in practise would also sidestep any appearance of messy public bargaining with Spain about what ECB support would actually mean. A drop in Portuguese yields, and the implied backstop for Spain if it chooses to make a formal request support, may take some of the market pressure off Spain to actually make such a request.

He thinks non-action would only be justified by “flimsy excuses”, which are:

1. That full programme countries are different.

They are already out of the market so support wouldn’t be appropriate. The obvious counter, says Barr, is that elevated secondary market yields on the outstanding stock of government debt are still a brake on growth, as Draghi himself has suggested.

2. There might be an insistence on a separate application for EFSF bond market support.

But countries in a full programme are already subject to heavy conditionality so what would that additional procedural step achieve? And what would Portugal lose by requesting?

3. Await the latest Troika review.

An old favourite. The latest Troika review of Portugal’s adjustment programme will take place in September. But Barr does not see that there are solid grounds for the ECB to declare Portuguese programme compliance is being in substantial doubt, given the assessments of the Troika to date.

Related links:
Portugal’s biggest risk is Spain – Sober Look
Portugal and a second bailout - FT Alpahville