Losses Deepen in Europe’s Worst Bond Market as Draghi Stands Pat

Updated on
  • Portugal’s bonds have fallen since ECB started QE buying
  • DBRS to review Portugal’s investment grade rating on Oct. 21

In rally or rout, Portuguese bonds are stuck as Europe’s worst performers.

Yields jumped to their highest since July after European Central Bank President Mario Draghi downplayed the need for more economic stimulus, which has included purchases of billions of euros of government securities through its quantitative easing program. Portugal was already the worst-performing market in the euro region and as European bonds tumbled at the end of last week it once again suffered the most.

The country exited an international bailout program about six months after Ireland, but has been singled out by investors because of political dawdling over budget cuts, the sustainability of its debt and the money it needs to pump into ailing banks. Portugal’s 10-year bonds yield 3.23 percent, up more than 70 basis points since January 2015 when the ECB unveiled its QE plans. Irish yields tumbled 70 points to 0.5 percent.

“Portugal needs growth and needs to reduce debt,” said Filipe Silva, an asset manager at Banco Carregosa SA in Oporto, northern Portugal. “It has to be able to lower the perception of risk that some investors have.”

Portuguese debt lost investors 1.3 percent this year compared with gains for everywhere else, according to Bloomberg World Bond Indexes. 

The country is rated junk by Fitch Ratings, Moody’s Investors Service and S&P Global Ratings, so it’s only a higher one from DBRS Ltd. that makes its bonds eligible to be bought by the ECB as part of QE. DBRS is due to review Portugal’s rating again on Oct. 21, though it kept the country at investment grade in April.

The amount of Portuguese government bonds bought under the asset-purchase program fell to 722 million euros ($810 million) in August, the lowest since the inception of the stimulus plan in March last year. Mario Draghi said on Thursday the ECB’s governing council didn’t discuss the prospect of more QE at its latest meeting.

Another Budget

Then there’s the budget and banks. Prime Minister Antonio Costa was sworn in at the end of November and his minority Socialist government is reversing state salary cuts faster than the previous administration proposed while increasing indirect taxes. Portugal, along with Spain, avoided a landmark penalty from the European Union for persistently missing budget targets and its 2017 spending plan is due in October.

Costa said on Aug. 31 that the 2016 budget deficit will be “comfortably” below the 2.5 percent target from the European Commission.

The wildcard is a planned 2.7 billion-euro capital injection into state-owned bank Caixa Geral de Depositos SA that “will require a redesign of the profile and the level of Portugal’s public debt,” Finance Minister Mario Centeno said. The government in April had forecast that debt would fall for a second year in 2016 to 125 percent of gross domestic product.

“The current coalition government’s course has been bond market ‘unfriendly’ and investors have feared that ECB QE may come to an end,” said David Schnautz, an interest rate strategist at Commerzbank AG. For Portuguese bonds to perform better, investors need to gain confidence in the government “to implement reform again rather than scaling past reforms back,” he said.