Here's One Way to Trade Portugal's Promotion From Junk Ratings

There’s not much juice left in the Portuguese debt rally for investors who play it straight, according to strategists at Rabobank International. But there may still be gains to be had.

Yields have come about as close as they can to those on German bunds, having reached a spread Rabobank deems fair value at 200 basis points, strategists led by Richard McGuire wrote in a note Tuesday. The market has now priced in upgrades by Moody’s Investors Service Ltd. and Fitch Ratings Ltd. to match S&P Global Ratings’ promotion to investment-grade.

Instead of an outright long position, McGuire and his colleagues recommend buying Portuguese government bonds in a pair trade that shorts Italian debt. Italy’s bonds look vulnerable given Rome’s elevated debt burden, the fact the Italian central bank owns a greater share of its nation’s bonds, and a general election next year that could dampen risk appetite, they said.

The strategy may be one defense against European Central Bank taper as soon as January, the same month Portugal is likely to re-enter investment-grade benchmark indexes, the strategists write.

Unicredit SpA analysts said debt issued by Lisbon is unlikely to trade tighter than similar-duration Italian bonds, citing the latter’s greater liquidity, but they foresee a flatter Portuguese yield curve.

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