Some Thoughts On Portugal

By Win Thin

Portugal remains in the market spotlight as its 10-year yield remains above 7% for the 10^th straight day. Furthermore, today Portugal’s 5-year yield broke above 7% for the first time and continues the pattern that we saw with Greece and Ireland. In both those cases, the 10-year yield was the first to break above 7%, with the 5-year and then the 2-year yields breaking above that level in the ensuing days. It is noteworthy is that the rescue packages for those countries have done nothing to substantially lower their borrowing costs, with 10-year yields still substantially above 7% for both. With contagion showing no signs of abating, we think Portugal is doomed to the same fate.

What about the next likely victim? Spain 10-year yields are the next highest in the periphery and now around 5.39%. But note that Ireland 10-year yields were around 4.6% right after the Greece rescue package was announced, and that Portugal 10-year yields were just above 5.9% right after the Ireland rescue package was announced. The timeline between rescues appears to have shortened, with close to 7 months between Greece and Ireland but likely down to 3-4 months between Ireland and Portugal if current trends continue.

Portuguese press reported today that Germany is pushing the country to take a rescue package as soon as possible, and before European leaders unveil long-awaited changes to its rescue fund in March. We had thought that Portugal might wait to tap the rescue fund at the same time that the changes are announced next month, but the timing is not that crucial. Rather, bond markets are signaling that a rescue for Portugal is seen as pretty much inevitable. Note that Portugal central bank Governor Costa yesterday admitted that the economy is already in recession and will remain so in 2011. Portugal contracted q/q in Q4, so it appears that Costa is looking for continued contraction in Q1 and beyond. High borrowing costs plus economic contraction means that the debt dynamics will continue to unravel. Indeed, that is why Greece and Ireland debt ratios are going to get worse for several years still.