No Love for Portugal Bonds as Debt-Burden Woes Eclipse Stability

  • While economy is accelerating, indebtedness remains high
  • Portugal’s bonds have fallen since ECB started QE buying

Portugal’s string of good news is getting little attention from investors.

Its Prime Minister Antonio Costa just got his second budget through parliament, its economy is picking up and the country stands out as a beacon of stability in the midst of the turmoil set off by Brexit, a referendum in Italy that might bring down the government and rising populism. For all that, investors aren’t showing Portugal’s bonds any love, with the securities caught up in the global fixed-income sell off following Donald Trump’s election.

“The domestic news has in fact been good, but there was a bigger event which
was the election of Trump and the increase in U.S. yields,” said Diogo Teixeira, chief executive officer of Optimize Investment Partners, a Lisbon-based firm that manages about 125 million euros ($132 million). It hasn’t helped that Portugal remains deeply indebted, he said. “If we look in greater depth, the structure of indebtedness hasn’t changed. The good news will be when we have an inversion in the level of indebtedness.”

Even with the European Central Bank’s debt purchases, Portugal is the euro region’s worst-performing sovereign-bond market this year through Tuesday, according to Bloomberg World Bond Indexes. The nation’s securities have lost 3 percent, which is more than Italy’s losses and compares with gains elsewhere in the bloc.

Investors point to the fact that although Portugal brings a lot to the table, many of its underlying problems remain. Although the country exited its three-year international bailout program in 2014, it’s still dealing with issues including bad loans at banks. While growth accelerated in the third quarter, the government cut its economic outlook when it presented the 2017 budget in October and said the debt ratio will be higher than previously forecast.

Italy, Greece

Portugal’s 10-year bonds yield 3.7 percent, up from 2.4 percent at the start of January 2015, the month when ECB President Mario Draghi unveiled his quantitative easing program. It peaked at 18 percent in 2012 at the height of the euro region’s debt crisis. The yield difference with Germany has widened to 3.5 percentage points.

Meanwhile, although Italy’s bonds are the worst performers in the past month as Italian Prime Minister Matteo Renzi faces a key vote on Sunday that may see voters reject his constitutional reform and prompt his resignation, they’ve fared better than Portuguese paper over the year.

Also, while Greek bonds don’t qualify for the ECB’s bond buying, the premium of Greek 10-year debt over similar Portuguese securities has halved since the start of 2015.

“We have to be prepared for a continued increase in yields,” Optimize’s Teixeira said. “At the end of 2017 we may have German 10-year yields above 1 percent and Portuguese 10-year yields above 4 percent.”

Trying Hard

At about 232 billion euros, Portugal’s debt stands at 129 percent of gross domestic product -- the third-highest in the euro area behind Greece and Italy.

Portugal has been trying to make the best of a bad situation. Premier Costa has been able to comply with European Union fiscal commitments and satisfy some demands from the more radical parties that have propped up his government. The government took office at the end of November 2015 and is reversing state salary cuts faster than the previous administration proposed, while increasing indirect taxes.

Portugal’s credit rating was retained at investment grade by DBRS Ltd. on Oct. 21, securing eligibility of the country’s debt for the ECB’s bond purchase program. The government’s debt is rated junk by Fitch Ratings, Moody’s Investors Service and S&P Global Ratings.

“Despite the fact that we were expecting instability in the government, that hasn’t been the case,” said Nichola James, co-head of sovereign ratings at DBRS.

The unemployment rate fell for a second quarter in the three months through September to 10.5 percent. The government forecasts an expansion of 1.2 percent in 2016 and 1.5 percent in 2017. It expects the budget deficit to narrow to 2.4 percent of GDP in 2016, within a 2.5 percent target set by the European Commission.

“At this stage, fear trumps greed, so the extra spread Portuguese government bonds offer seem to be not triggering hunt-for-yield demand,” said David Schnautz, an interest rate strategist at Commerzbank AG in London. “Heading into year-end, some investors may have a preference to be invested in performing assets - and among EMU sovereign bonds, Portuguese government bonds have been the underperformers.”

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