THE BOND VIGILANTES AWAIT PORTUGAL WITH OPEN ARMS

by Cullen Roche

Tuesday’s Portuguese bond auctions don’t appear to have rattled investors too badly, however, the math continues to grow increasingly challenging for them. According to EU officials, Portugal cannot sustain rates over 7%.  Of course, this is where bond vigilantes are pushing the yields.  For them, it’s a win win.  Why not get a nice fat yield with a government guarantee on top?   And at these continued rates that’s exactly what’s coming.

Portuguese 10 Year Yield

The FT reported today that the ECB was forced back into the market to help stabilize surging yields:

“The European Central Bank has intervened in eurozone bond markets for the first time in weeks, buying Portuguese debt amid fears that the country could yet seek an international rescue.

The ECB returned to the market on Thursday as Portugal’s cost of borrowing on 10-year debt jumped to a euro-era high of 7.63 per cent, traders said. The ECB temporarily suspended its bond-buying programme in mid-January.”

And the reasoning behind the ECB’s actions is simple when one looks under the hood at recent auctions.  As Place de Luxembourg explains, these auctions have deteriorated substantially:

“Despite the fact that this was a syndicated debt auction, they were very sneaky, as no ex-ante reference was made to the auction on the debt agency’s website.

In order to understand how the markets price Portugal, and in the impossibility of accessing ReuterThomson Datastream information, the best thing to do is to study the interest rates charged for this new line of debt. On this occasion, Portugal was charged a 6.4% interest rate. This you might be forgiven to think was an imporvement to the 6.67% it paid on its January auction, but you’d still be wrong. The truth is that these are 5 year bonds where as the previous were 10 year bonds. Actually at that time (January 2010), Portugal also auctioned a number of 5 year bond and the sad truth is that these were charged an interest of  5.449%. This implies that  for a similar time span, the cost of Portuguese borrowing increased by ~ 17.43%. So there is nothing to celebrate. It’s fair to conclude that the situation continues to get worse…”

So, Portugal appears to be on the chopping block and we all know it.  The EMU has made it abundantly clear that no defaults will be allowed, however, the situation could become politically strained when the markets take their focus off of Portugal and start looking at Spain.

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