Portuguese Underperformance
Portugal is grabbing the headlines currently for all the wrong reasons, and we at TwentyFour have voiced material concerns since Madeira admitted in August to a €500m fiscal slippage. However, it is not likely to be all one-way traffic for the bears.
As I type, Portugal has 10 year yields of over 15%, meaning that bonds are trading in the low 40s. If investors want to insure themselves against a Portuguese default, it will cost them more than 40 points upfront plus a running 500bp. The S&P downgrades of large parts of the EU prompted the sell off in Portugal, despite the other nations shrugging off the news. Portugal is now rated as junk by all the rating agencies.
Portugal has not only de-coupled itself from Ireland, another of the bailout recipients, it is sprinting to catch up Greece as investors have rushed to dump their exposures. Despite the Euro-leaders saying otherwise, there are fears of another painful PSI deal on investors’ minds; while Greece is still negotiating with its creditors on what losses they are willing to accept. The fundamental position in Portugal also certainly supports some of this fear. In three of the last four years the country has experienced recession, consequently gross debt as a percentage of GDP has risen to 93.3% (2010) and is forecast to be 106% when finalised for 2011. Additionally, there are concerns that a funding gap is emerging in September 2013 when it was planned for Portugal to re-tap the markets again. All this uncertainty means that there is no doubt that Portugal is next in line behind Greece for market speculation and the contagion effect.
However, while the bears clearly have the upper hand at the moment, it is worth remembering that Portugal has none of the refinancing risks of Italy or Spain, as its €24bn of maturities in 2012 are covered by their programme. Additionally, their total debt of €161bn is still manageable relative to the size of the Troika’s war chest (approx. €750bn if you combine the EFSF and the ESM). Portugal, unlike Greece, has received positive reports from the Troika’s inspections, with the vast majority of the austerity measures having been implemented and state asset sales moving ahead as planned. Consequently, Portugal has the strong support of the EU which is at pains to explain that Greece is a one-off and that there will be no PSI for Portugal (just like they said for Greece a year ago!). This was the clear message from politicians as they left the 16th Euro Crisis Summit yesterday. So even if additional bailout sums are required, it seems more likely than not that Portugal will receive them.
This of course is all talk and it has been actual selling that has pushed Portuguese bond prices lower, so it is only likely to be fresh buying that will reverse the current trend. On that note maybe help is at hand. Next month the ECB will take over running the EFSF, and under certain distressed circumstances the Fund will be able to buy secondary sovereign debt if a member country requests assistance and the ECB sees the situation as posing a risk to the Euro area. As Greece nears the point of its “restructuring” ahead of the March 20th bond redemption, the contagion pressures are mounting considerably on Portugal, it would be reasonable to assume that further pressure on Portuguese bonds could be deemed as posing a risk to the Euro area, so if Prime Minister Pedro Coelho asks for assistance, the ECB may direct its first EFSF purchases towards Portugal. Given the firepower of the secondary purchases (up to 10% of Portugal’s GDP), a very sharp rebound could occur. Additionally, the timing of this may fit well with the 29th February LTRO when another round of unlimited liquidity is offered to the banking system.
We have no exposure to Portugal, nor are we likely to in the near future, but for the very very brave …..it seems that markets may have raced ahead of fundamentals and a bear bounce may be likely soon.