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Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

The prodigal son has returned. Portugal is back in investment grade territory after S&P Global Ratings on Friday raised its sovereign rating to BBB- from BB+, citing Portugal’s steady progress on reducing its budget deficit and prospects for faster growth.

Ten year Portugal bond yields at the start of 2017 were around 4.5 percent, now they are below 2.5 percent. Economic progress has been good, but not that good to make a dent in its overwhelming pile of debt. This upgrade was already more than fully priced in. In fact, it is hard to see how much further Portuguese yields can justifiably fall after a 30 basis point plunge on Monday.

Peripheral Star
Portugal's yield spread over Germany has nearly halved this year
Source: Bloomberg

The main reason the rating companies knocked Portugal into junk territory five years ago, at the height of the euro crisis, was because of its unsustainable debt load. And progress on that has been glacial. The bonds' outperformance is much more due to their relative scarcity rather than any sudden economic transformation.

Portugal is one of the few European countries to feature in all of the European Central Bank's support mechanisms. The central bank now owns very close to one-third of all the country's outstanding debt. That is the maximum allowed under the ECB’s QE program rules.

Relative Outperformer
The spread between the two similarly indebted peripherals has collapsed this year due to relative scarcity of Portuguese bonds available to buy.
Source: Bloomberg

Monday's yield drop could reflect some anticipation that S&P’s upgrade will widen the eligible investor base, as it raises the prospect that the bonds may be eligible for funds that can only buy investment-grade securities. But there's more to it than that. Many funds require investment grade ratings from two of the three major rating companies -- S&P, Moody's Investors Service and Fitch Ratings. The last two still rate Portugal one notch below investment grade, though with a positive outlook.

And for the major bond fund indexes, the restrictions are even tighter. For instance, despite the S&P upgrade, Portugal will still be excluded from Citigroup Inc.'s World Government Bond Index. This requires sovereigns that have lost their investment grade and been dropped from the index to achieve ratings of at least A- at S&P or A3 at Moody’s in order to requalify -- Fitch doesn't figure into it.

Debt Overhang
While the Portuguese economy has improved, improvement in its debt position is negligible
Source: Eurostat

Similarly, the recent rating change isn't sufficient for inclusion in the Bloomberg Barclays Indices of Bloomberg LP, the parent company of Gadfly. 

The odd one out is Canadian rating company DBRS Ltd., which has valiantly kept Portugal at BBBL, one level above junk, throughout the crisis. To be eligible for ECB purchases, a sovereign needs to have investment grade ratings from one of the four agencies -- the three above, plus DBRS. This agency's assessment had the vital result of allowing the ECB to keep administering all its QE medicine. DBRS does not have the same relevance for investors.

Even if it did, it is doubtful that fund managers newly able to invest in Portugal will leap in after such a staggering drop in yield. With a debt to GDP ratio in excess of 125 percent, its debt load is utterly unsustainable -- but for the unwavering support from the central bank. All hail the ECB.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net