Portugal Yields Need Draghi to Keep His OMT Promise
Portugal’s 10-year bond yield jumped more than a percentage point in the past month to levels that may test European Central Bank President Mario Draghi’s pledge to buy bonds of crisis-torn countries.
Portugal pays 6.9 percent to borrow for a decade, up from a six-month average of 6.07 percent and more than double the average interest rate of 3.2 percent that it pays for its aid loans. Two-year funding costs have soared to 3.6 percent from as low as 2.4 percent during the first week of May.
Draghi has pledged Outright Monetary Transactions to cap yields with unlimited secondary-market debt purchases for countries either in an economic adjustment program or entering one. Almost a year after he revealed the plan, no country has asked for help as Portuguese rates renew their climb.
“Borrowing costs are much higher than the economy can stand in the long term, it isn’t sustainable,” said Orlando Green, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London. Implementing the OMT “would certainly help accelerate the process of being in a position to borrow at sustainable levels,” he said.
Bonds tumbled around the world last week after Federal Reserve Chairman Ben S. Bernanke said U.S. policy makers may end asset purchases in mid-2014. The 10-year U.S. Treasury yield, a benchmark for sovereign borrowing costs, has risen to 2.5 percent from as low as 1.63 percent at the start of last month.
Draghi, speaking in Berlin today, defended the ECB’s as-yet-unused bond-purchase program, signaling its presence may help curb volatility. “OMT is even more essential now as we see potential changes in the monetary policy stance with associated uncertainty in other jurisdictions of the integrated global economy,” he said.
In Portugal (GSPT10YR), the government projects gross domestic product will contract 2.3 percent this year before growing 0.6 percent next year. The jobless rate will climb to 18.2 percent in 2013 and 18.5 percent in 2014 from 15.7 percent at the end of last year.
“Portugal is regaining full-market access and full-market access will guarantee the eligibility for the OMT program,” Manuel Rodrigues, the secretary of state for finance, said in a June 4 Bloomberg Television interview from New York. “We are working on ensuring that we are eligible for this program.”
The nation’s poor fiscal and growth prospects mean it will probably request at least a precautionary credit line from the European Stability Mechanism following the 78 billion-euro ($102 billion) bailout from the European Union and the International Monetary Fund, Ricardo Santos, an economist at BNP Paribas SA in London, said June 17 in a telephone interview. That should make Portugal’s assets eligible for ECB OMT buying.
The EU is reviewing possible “precautionary arrangements” that might help Ireland and Portugal exit their aid programs, Economic and Monetary Commissioner Olli Rehn told European Parliament lawmakers in Brussels on June 17. Ireland probably will apply for such a facility, two people familiar with the matter said June 20. Irish 10-year yields are about 4.3 percent, up from an average this year of 3.82 percent.
“A low borrowing rate will likely only be achieved through some new loan arrangement,” said Ciaran O’Hagan, head of European rates strategy at Societe Generale SA in Paris. “Market yields today, even if down sharply over the past year, are just simply too high to prevent Ireland’s and Portugal’s debt burdens from continuing to spiral upwards, in the absence of much if any growth.”
Portugal sold 10-year debt last month for the first time in more than two years as yields on the country’s existing bonds were at the lowest since 2010 and a decline in interest rates worldwide led investors to seek higher-yielding assets. The country stopped selling bonds until this year after requesting the bailout in April 2011.
Abebe Aemro Selassie, head of the International Monetary Fund’s mission to Portugal, told reporters on a June 13 call that it was urgent that market “fragmentation and high lending rates in Portugal” be addressed as soon as possible.
Selassie said the ECB’s OMT was one option, adding that any help the central bank could give that bolsters the access of small- and medium-sized companies to credit was “key.”
“The OMT doesn’t have to be active, we don’t actually have to see the ECB buying bonds, but if that is taken away or softened it might make things harder for Portugal,” said David Schnautz, a strategist at Commerzbank AG in New York. “Portugal needs some kind of backstop.”
Portuguese President Anibal Cavaco Silva has urged Draghi to help the country emerge from recession and an aid program by buying the country’s debt in the secondary market and improving the financing conditions and access to credit for small businesses.
“I believe Portugal qualifies for secondary-market intervention for public debt, which the European Central Bank at one point said they would be able to carry out,” Cavaco Silva told reporters June 12 at the European Parliament in Strasbourg, France. A “fragmentation” in the credit markets is “threatening the integrity of the European currency,” he said.
Schnautz at Commerzbank said investors seemed to have lost their focus on the importance of European lenders having agreed to extend the maturities of the country’s bailout loans, which may help drive down yields. A final decision on this was taken by the euro-area finance ministers June 21 in Luxembourg.
Schnautz sees Portugal coming back to the primary bond market in September. “Issuance needs to remain opportunistic, there needs to be some degree of freedom to do it when the market is ready,” he said. “The OMT isn’t the only tool in town. From the market’s perspective, it’s the best.”
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