Portuguese Bonds' Wild Ride Shows Vulnerability Amid Budget Woes

Updated on
  • 10-year debt has biggest weekly yield swing since July 2013
  • Portugal's securities underperform Italian, Spanish peers

It’s been quite the wild ride for investors in Portuguese government bonds in 2016 and, with history seeming to repeat itself, there’s no end in sight.

Portugal’s 10-year bond yields moved in a range of 143 basis points this week amid concern that lawmakers’ plans to speed up the reversal of state salary cuts and increase indirect taxes will hit its reform program. That’s the largest weekly yield swing since July 2013 -- a time when Portugal’s two governing parties were split over the budget measures required to complete its bailout.

Portugal has borne the brunt of this week’s selloff in the securities of Europe’s higher-debt and -deficit nations. While Minister of the Presidency Maria Marques said Thursday that the increase in Portuguese bond yields isn’t linked to the discussion on the budget, the jump in 10-year yields since Feb. 5 was six times greater than that on the securities of neighboring Spain.

“When you look at Portugal it’s a completely different kettle of fish” to Italy or Spain, said Peter Schaffrik, head of European rates strategy at Royal Bank of Canada in London. “It’s easy to see why trouble is brewing. In Portugal, on top of that, you have a government that’s not delivering what the market wants to see and as a result of that I’d certainly be cautious.”

Portugal’s 10-year bond yield fell 37 basis points, or 0.37 percentage point, to 3.73 percent at the 5 p.m. close in London, after earlier rising as much as 34 basis points. The 2.875 percent security due in July 2026 gained 2.975, or 29.75 euros per 1,000-euro ($1,125) face amount, to 92.705. The 10-year yield climbed to 4.53 percent Thursday, the highest since March 2014.

Two-Year Yield

The nation’s two-year note yield was little changed at 1.20 percent Friday after rising to 1.76 percent earlier, the highest since May 2014.

Thin liquidity is also helping to propel the moves in Portuguese debt. The difference between the bid and offer yields for Portugal’s 10-year securities was more than five basis points Friday, according to data compiled by Bloomberg. In contrast, the spread on similar-maturity German bunds was about 0.1 basis point. It’s used as a gauge of liquidity because the wider spread indicates market makers pricing in a higher risk to trade the securities.

Junk Rating

Portugal’s sovereign debt is rated below investment grade, or junk, by Fitch Ratings, Moody’s Investors Service and Standard & Poor’s. The credit rating was retained at investment grade by DBRS Ltd. on Nov. 13, securing its eligibility for inclusion in the European Central Bank’s bond-buying plan.

Investors may be reducing their positions in Portugal’s bonds amid concern that DBRS will cut its sovereign rating, thereby risking eligibility for ECB purchases of its debt, according to strategists at Commerzbank AG, including London-based David Schnautz.

DBRS warned Friday that market volatility may result in slower economic growth in Portugal, saying rising yields are a “concern,” in an e-mailed report. The company is scheduled to next report on Portugal’s rating on April 29.

Euro-area finance ministers told Portugal Thursday to make plans to cut its budget further in case it runs into trouble meeting its targets, noting that the country is at risk of missing goals.

Italy’s 10-year bond yield fell six basis points to 1.65 percent Friday, trimming this week’s increase to 10 basis points. The yield on similar-maturity Spanish debt dropped four basis points to 1.74 percent for a 10 basis-point gain since Feb. 5. That compares with a weekly jump of 60 basis points on Portuguese 10-year securities.