IFR Comment: Once bitten, twice shy on Portugal

With Portugal seeing 10-year spreads and 5-year CDS hitting record wides today, the expectation is we are moving closer to a Greek-type scenario. Growth dynamics, the political situation, and tax collection are all factors which support optimism that another bailout for Portugal will be as volatility-inducing and a as big a disturbance to the market as Greece.

The higher funding costs for Portugal will mean that another bailout will be needed and likely negotiated in Q3 or even Q4 (to which the French presidential elections will add another layer of uncertainty)

However, investors battered by a political landscape dominated by dithering, delays, and dogma, have little patience in holding on to Portuguese sovereign debt. Why take the risk of being forced to walk down the same messy road as Greece when it came to its second bailout and PSI discussions? Things might have been different had there been the prospect of hedging cash positions via CDS, but the lack of a “credit event” on Greece has made even this avenue less viable.

What has been worrying is that the ECB has shown a limited interest in buying Portuguese debt via its SMP, despite a material and significant widening in bid/offer spreads. One explanation has been that the ECB is worried about expanding its exposure at a time when it is under pressure to take losses on its Greek debt holdings. If a public entity is unwilling to support a dysfunctional market, then there is no reason why private investors should not show similar concerns and head for the exit.

The higher funding costs for Portugal will mean that another bailout will be needed and likely negotiated in Q3 or even Q4 (to which the French presidential elections will add another layer of uncertainty). A prerequisite will be Portugal showing it is politically willing to keep to the existing austerity plan. But the big unknown is whether politically another bailout will once again require private sector investors to be bailed in, or if Greece is truly a one-off when it comes to PSI.

There is an abundance of risk for investors to worry about, and for many stuck with positions on Greece and now Portugal, it is still about making sure you are not walking down the path of the next land mine to explode. This means Ireland will also tag along for the negative sentiment ride, although Spain and Italy have both been provided more time via the ECB’s LTRO.