Morgan Stanley's Fels Sees Spain as Probable Target If Portugal Is Rescued

Portugal will need a bailout and investors will then focus on Spain as there’s “little to stop the contagion” from Europe’s sovereign-debt crisis, said Joachim Fels, co-chief global economist at Morgan Stanley.

“I think investors have lost confidence in the ability of Portugal to turn around its situation, so it looks like Portugal will be forced into the EFSF,” Europe’s bailout fund, Fels said today in an interview on Bloomberg Television’s “Inside Track” with Erik Schatzker. “I think the focus is now on Portugal and then I think the markets will turn to Spain.”

Spanish Finance Minister Elena Salgado said today the country won’t need a bailout as borrowing costs surged for Europe’s so-called peripheral countries after Ireland’s request for aid prompted speculation that other nations may need help. The difference in yield, or spread, between Spanish 10-year bonds and German bunds surged to a euro-era high of 249 basis points today. Portugal’s spread was at 434 basis points.

Ireland this week became the first nation to tap the European Financial Stability Facility, the euro region’s 750 billion-euro ($1 trillion) rescue fund set up in May after Greece’s near-default. It asked for help after the cost of saving its financial industry swelled the budget deficit to an estimated 32 percent of gross domestic product this year, 10 times the European Union’s limit.

‘Enough is Enough’

“There will come a point when governments will say ‘enough is enough, and we will rather borrow from the EFSF at a sensible rate,’ which is lower than the market rate,” Fels said. “Portugal is already there. Portuguese three-year bonds trade at a five and a half percent yield -- that’s higher than the yield at which Portugal could borrow from the fund.”

Spanish yields would have to approach 6 percent to 7 percent “in the short end of the curve” for the country to be close to needing aid, Fels said. “So we’re not there for Spain,” he said.

Bonds in Ireland, Portugal and Greece have slumped since EU leaders agreed on Oct. 29 to consider Germany’s proposal for a permanent rescue mechanism as of 2013 that would involve debt restructuring with losses for bondholders. German Chancellor Angela Merkel wants buyers of new euro-region bonds to accept liability clauses starting in 2011, two years before a revamped crisis-management system kicks in, according to a Finance Ministry document obtained by Bloomberg.

Merkel’s comments “have clearly made the crisis much worse,” Fels said.

To contact the editor responsible for this story: Jeffrey Donovan at jdonovan26@bloomberg.net

To contact the editor responsible for this story: John Fraher at jfraher@bloomberg.net

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