European officials have insisted that Greece is unique. Many market participants do not believe them. Portugal appears to be headed down that same road. While we have warned in the past of risks that Portugal would need a second aid package, it is only since S&P joined the other major rating agencies on January 13 that more market participants have come over to this view.
Portugal’s 10-year yield poked through the 15% level for the first time ever. On January 12th, the eve of the downgrade the yield was about 12.4%. The shorter end of the curve has also been crushed and 2-10 yr is inverted. The 2-year was yielding 12.31% before the S&P downgrade. Now it is approaching 17%.
After Greece, insurance on Portuguese debt is the most expensive in the world. The 5-year CDS was at 1066 on the Jan 12th and is at a new record high of 1425 today. The risk of a default has risen from about 62% on Jan 12 to near 75% today.
Of course, Portuguese officials are right. Portuguese macro fundamentals are superior to Greece. Debt/GDP is lower at about 112% vs almost 190% for Greece, for example. It has about 129 bln euros of outstanding debt instruments and the average maturity is just below 6 years.
Yet the difference is not of a sufficient magnitude to keep the wolf away from the door. The 78 bln euro aid package was too keep Portugal form having to issue medium and long term debt until May 2013. In October 2013, Portugal has a 9 bln euro bond maturing that it will need to roll.
This may seem to be too far in the future to be very meaningful, but these kind of things seem to take on a life of their own. Since Portugal is rated below investment grade, it is being ejected from benchmark indices that numerous fund manager use.
Once the investment grade status is lost, it takes some time (and effort) to recoup it. Moreover, conditions are likely to get worse in the coming months. Consider that the economy, that appears to have contracted by 1.6% in 2011 is expected to contract 3.5% this year and another 1% next year.
The risk that Portugal will not be able to return to the capital markets next year is important and it will require more aid. If Greece got to be forgiven for half the debt in private hands, why should Portugal not ask for some forgiveness too?
The rules of private sector engagement are IMF practices and the IMF often seeks private sector involvement/haircuts, as a condition of reducing debt to sustainable levels. Officials might not be able to say as much, but investors beginning to anticipate this eventuality.
Just as important the pressure on Portugal shows that the firewall around Greece, hoped to have been strengthened by the LTRO and euro area official efforts, has been breached. Portugal is where Greece was 6-9 months ago. The question is while Portugal be where Greece is today toward the end of the year. Unless European officials take preventative action the rot will continue and the contagion risk remains real.
About Marc Chandler
Marc Chandler joined Brown Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. In addition to frequently providing insight into the developments of the day to newspapers and news wires, Chandler's essays have been published in the Financial Times, Barron's, Euromoney, Corporate Finance, and Foreign Affairs. Marc appears often on business television and is a regular guest on CNBC.
Like us on Facebook
- No Twitter messages.
- Excess German savings, not thrift, caused the European crisis
- On Greece’s eventual exit from the eurozone
- Links: 2013-05-21
- On Germany’s response to Euroland’s problems
- Germany is willing to accept a higher inflation target but does it matter?
- Links: 2013-05-20
- Links: 2013-05-19
- Links: 2013-05-18
- Links: 2013-05-17
- Full text: Moody’s upgrades Turkey’s government bond ratings to Baa3, stable outlook
- Some thoughts on Canada’s housing market
- On big data and why Google’s Android is winning and fragmentation is no longer a problem
- Links: 2013-05-16
- Europe’s sinking economy
- Links: 2013-05-15
- Has house price deflation begun in Canada?
- Portugal’s Japanese Problem
- Feedback Loops
- The real experiment that is being carried out in Japan
- Android is killing iOS with nearly 75% share in Q1 2013
- Links: 2013-05-14
- Some more thoughts on mobile-based computing
- Links: 2013-05-13
- Some quick thoughts on quantitative easing and zero rate policy
- Zero rates mean Americans are giving up on Certificates of Deposits
- Kyle Bass gets it wrong on Japanese bonds
- On claims of depositors, subordinated and creditors and central banks in bank resolutions
- Money is Gold
- Massive Iceberg Ahead for the European Monetary Union
- On Japan’s widowmaker trade and Reinhart and Rogoff
- Why the Reinhart-Rogoff paper was flawed right from the start
- A reality check on German household wealth
- Buiter: Most European banks are zombies
- On the crash in gold
- The Need for Wholesale Change
- What are the differences between QE1, QE2 and QE3?
- Spain’s economy is in tatters
- Buiter: ‘it was clear that Cyprus was a laboratory’
- In the long run we are all in trouble
- The largest European banks by assets
- Deposit insurance after Iceland and Cyprus
- Cyprus Bailout Deal Terms
- Why Germans are poor
- Chart of the Day: Debt Deflation in the Eurozone
- How bond market vigilantes force rates higher