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Portugal in Crosshairs as Yields Fuel Bailout Talk: Euro Credit

Portugal's Prime Minister Pedro Passos Coelho reacts during a television interview in Lisbon. Photographer: Mario Proenca/Bloomberg
Portugal's Prime Minister Pedro Passos Coelho reacts during a television interview in Lisbon. Photographer: Mario Proenca/Bloomberg

March 6 (Bloomberg) -- Portuguese bond yields are rising as investors are busy putting cheap money from the European Central Bank to work elsewhere.

The increase in 10-year borrowing costs by almost two percentage points in the past two weeks is stoking concern among investors that the nation will struggle to resume bond sales in 2013. Portugal has been unable to sell debt due in more than a year since it was given a 78 billion-euro ($102.3 billion) bailout in May 2011, following Greece and Ireland.

“The ECB’s cash provides liquidity, but not solvency,” said Stuart Thomson, who helps oversee the equivalent of $110 billion as a portfolio manager at Ignis Asset Management in Glasgow. “If the perception is that a country is already bankrupt, these liquidity measures won’t work. There is growing concern that Portugal may need a second bailout.”

Portugal’s 10-year yield was at 13.94 percent at 4:54 p.m. in London, up from 7.48 percent a year ago. The extra yield investors demand to own the nation’s bonds rather than Germany’s widened 1.22 percentage points to 12.16 percentage points since the ECB announced its program of three-year loans to banks on Dec. 8. Italy’s spread shrank 115 basis points to 3.29 percentage point, and Spain’s narrowed 43 basis points to 3.37.

Portuguese bonds have returned 0.4 percent since the ECB offered euro-area banks its first round of three-year loans on Dec. 22. Investors have made 13 percent on Italian bonds, 11 percent on Irish securities, and 5.2 percent from Spanish debt, indexes compiled by Bank of America Merrill Lynch show.

Resuming Sales

Portugal’s government, which has been able to keep issuing bills, plans to restart bond sales in September 2013, Prime Minister Pedro Passos Coelho said Feb. 17. The International Monetary Fund said yesterday the country should be able to access the market next year as planned.

“That’s not going to be possible,” said Pavan Wadhwa, global head of interest-rate strategy at JPMorgan Chase & Co. in London. “The Portuguese 10-year yield is near 15 percent. No one goes to the market at that level. Once your yields go above 8 percent, there’s no turning back.”

While the country’s 10-year yields surged to a euro-era record 18.29 percent on Jan. 31, borrowing costs have declined at the country’s bill sales. Portugal sold 8 billion euros of bills this year, surpassing the indicative amount of 6.5 billion euros for the first quarter that the government announced on Dec. 29. The nation has also issued bills with longer maturities than initially proposed.

Forced Losses

The demand for bills and lack of interest in bonds suggests some investors are concerned they may be forced to take losses from their holdings of longer-maturity securities, JPMorgan’s Wadwa said.

Portugal’s junk ranking at Standard & Poor’s, Moody’s Investors Service and Fitch Ratings has sapped the attraction of its debt compared to those of its neighbors. Its bonds are Ba3 at Moody’s, three steps below investment grade, and BB at S&P, the second-highest junk ranking.

Italian and Spanish bonds have rallied since December amid speculation banks are using funds borrowed from the ECB to buy them. Italian 10-year yields dropped below 5 percent last week for the first time since August. Spanish 10-year yields have slid 22 basis points since the ECB held its first longer-term refinancing operation on Dec 22.

The ECB has lent euro-area banks more than 1 trillion euros at an interest rate of 1 percent in its two LTROs, providing 800 financial institutions with 529.5 billion euros on Feb. 29, after 523 banks borrowed 489 billion euros on Dec. 22.

Second Bailout?

“There is concern that a Greece-style bond restructuring will be required if Portugal were to take the second bailout,” said Wadhwa at JPMorgan. “Our baseline scenario is that they will need a second bailout. Bills are short-term securities used mostly for cash management and are likely to be excluded from debt restructuring.”

European leaders said in December that Greece’s situation was “exceptional and unique” and they don’t envisage bondholder losses in other nations that seek assistance.

“I don’t see any kind of possibility that my government could in a few years ask to restructure Portuguese debt,” Passos Coelho said yesterday in an interview.

Unlike Greece, Portugal is on track with its austerity measures. The nation should achieve its 2012 deficit target based on current forecasts, the International Monetary Fund said in a joint statement with the European Commission and ECB on Feb 28. The country also narrowed the shortfall to about 4 percent of gross domestic product in 2011 from 9.8 percent in 2010.

Unfavorable Math

Yet with the economy shrinking for the fifth quarter and unemployment climbing to 14 percent, Ignis’s Thomson said the country will still struggle to avoid another rescue package.

“Portugal has made progress, but the math still works against it,” he said. “The country has lower debt-to-GDP ratio than Greece. Its population is more compliant, and the government is working so hard. But the amount of fiscal austerity they have to do led to a contraction in GDP, and that makes it more difficult to reduce the budget deficit.”

Portugal’s economy will contract 3.3 percent this year, the European Commission predicted on Feb. 23. That’s a greater decline than estimated in November, when the Commission forecast a 3 percent drop.

S&P’s decision on Jan. 13 to cut Portugal’s credit rating to junk means the nation’s debt can no longer be held by some index-tracking funds. The elevated costs of credit-default swaps on Portuguese bonds signal a 64 percent chance the country will default within five years.

“The fact that Portugal remains under pressure is perhaps a warning that the ECB’s long-term loans are just a liquidity plaster, and not a solution,” said Richard McGuire, a senior fixed-income strategist at Rabobank International in London. “As long as the systemic weakness, and that’s fiscal disunity, is yet to be addressed, countries will remain vulnerable to contagion of one sort or another.”

To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net

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