After discussing the problems of the European Financial Stability Facility yesterday morning I was not surprised to see Standard and Poors downgrade its credit rating from AAA to AA+ in the evening. In my opinion S&P are still behind the curve as AA would be more appropriate for this troubled “rescue” vehicle and frankly you could argue for an even lower rating.
However whilst most of the downgraded countries in the Euro zone were able to shrug off the news -albeit in the case of Italy with the help of the European Central Bank buying its bonds- Portugal found a bomb going off in its government bond market.
What happened?
Portugal’s benchmark ten-year government bond fell by around 14% as its price fell from the 54s to the 47s. Accordingly the yield on this bond rose from 12.4% to 14.4% which is quite a one-day move to say the least! If we look at the behaviour of her shorter-dated bonds we saw a rise of 3% in the yield on her two-year bond from 12.7% to 15.7% so she was hit all along the curve.
What caused this?
The two notch downgrade by S&P to BB meant that Portugal is now at what is politely called sub-investment grade or less politely junk. That would have had an influence and in particular this means that she falls out of the Citibank world bond index, so holders of this would have to sell Portuguese bonds.
To this we can add two factors. The first is that markets supported by ECB buying tend to see a marked reduction in volume (this can be severe as when I analysed the Greek bond market the drop was to 10% of previous numbers) and this can lead to extreme swings. So we may not have seen that many sellers but simply no or very few buyers. Secondly the ECB did not buy Portuguese bonds yesterday according to reports.
Now whether you think that the ECB has given up on Portugal in a similar fashion to the way it did on Greece, or that it was busy in Italy, its lack of action may well have spooked the market and added to the decline. So all in all we may have had the equivalent of a “perfect storm” as several factors combined to have a big impact on Portugal’s bond market.
Perhaps another factor in the ECB’s thinking was that it was in the process of announcing a substantial acceleration in its bond buying. As we learnt yesterday that it had settled purchases of 3.77 billion Euros of peripheral bonds in the previous week making a total of 217 billion Euros. So it is possible that it is starting to feel overstretched on a policy that has already led to two resignations from its governing council.
Unfortunately for Portugal she has some 3,6 and 11 month bills to issue today in an en-action of Murphy’s Law.
Portugal’s economy is in serious trouble
The International Monetary Fund view
As part of its programme for aiding Portugal the IMF did a review of her position on the 19th of December, and as usual it opened with rose-tinted spectacles.
Good progress has been achieved so far on policy implementation.
Indeed so good that this happened.
the fiscal slippages in 2011 have prompted the use of banks’ pension fund assets to cover the gap
I guess future bank pensioners (if they look at what has happened to the use -or perhaps more accurately abuse- of pension assets in Ireland) may choke on the words “good progress” already! They may also wonder how coded the particular euphemism below is.
The environment facing banks is challenging
And if you read between the lines,so to speak, the IMF may even be worried about the vicious circle of austerity leading to economic contraction leading to more austerity that I have outlined often on this blog.
In light of the fiscal contraction and much weaker external demand it is even more critical to ensure that bank deleveraging does not come at the cost of excessive contraction in credit to dynamic enterprises.
So a fiscal contraction and weaker external demand and bank deleveraging? That is a recipe for a potential disaster and not a recovery in my book.
The latest evidence
Let me pass you over to the Portuguese INE
Services turnover index intensifies negative trend
In November, the year-on-year change rate of services turnover index, adjusted for calendar and seasonal effects, was -11.7% (-8.9% in the previous month). Comparing with November 2010, employment, wages and salaries and hours worked, adjusted for calendar effects, decreased by 4.9%, 3.0% and 4.7%, respectively. By the same order, the yearon- year change rates in October were -4.2%, -4.0% and -3.9%.
So we have the largest part of the economy not only declining but doing so at an accelerating rate. So a year on year reduction of 11.7% is severe and raises the risk of by-passing recession and going straight to a depression.
Oh well never mind maybe construction can help out.
The index of production in construction decreased by 11.6% in the quarter ending in November 2011, in year-on-year terms (3 months moving average, working days and seasonally adjusted), down by 1.4 percentage points from the rate observed in October. Employment and wages and salaries registered year-on-year change rates of -11.9% and -9.3%, respectively.
Or perhaps not! Surely Portugal’s tourism industry will give us a glimmer of summer?
The number of overnight stays in tourism accommodation establishments decreased by 3.4% towards the same month of the previous year, accounting for 1.9 million. This trend reversal was caused by the negative contribution of residents (-12.2%), since non residents maintained a positive evolution (+2%). The revenue from the activity revealed year-on-year decreases of 4.1% in total revenue and 3.6% in revenue from accommodation.
Before we sling a rope over the nearest beam the tourism figures had been up in 2011 but in the last few months even they show a “negative trend”.
We can have one more go with new orders for industry.
For the quarter ended in November 2011, industry new orders decreased 8.7% in year-on-year terms (change rate of 4.7% in October) partially reflecting a base effect occurred in the Intermediate goods industrial grouping. In the case of the external market, the index moved from a year-on-year change rate of 12.9% in October to -9.8% in November.
So we see that external demand looks like it is turning lower too and whilst one needs to treat a single months figures with some caution the scale of the move is nonetheless worrying.
Comment
Back on November 7th 2010 I discussed Portugal’s situation and gave this analysis.
If we take out the politics we can see that Portugal is in much worse shape than Italy with her only saving grace being a lower relative national debt level. So is yet another IMF austerity programme failing? It looks, sadly, as if this might be so.
One of the factors in me offering this opinion was an alarming fall in the level of retail sales in Portugal. And if we update the numbers from INE we see this.
In November, the retail trade turnover index (seasonally adjusted and at constant prices) registered a year-on-year change rate of -9.2% (-9.7% in October).
So as you can see that these numbers are horrible and have a trend which is again more akin to a depression than a recession. If we look at the latest bulletin from the Bank of Portugal it seems that it is beginning to cotton onto this as it has lowered its forecast for economic growth in 2012 to -3.1% with no recovery in 2013. Indeed the language used here is very strong for a central bank reviewing its own economy.
The domestic conditioning factors will imply an unprecedented contraction in private consumption.
And if we translate the euphemisms it does not think much of the way the Portuguese government acted in 2011.
It should be noted that the budgetary targets for 2011 were only fulfilled by resorting to a significant amount of self-reversible measures (that is, measures that do not have a permanent impact in the fiscal deficit and imply further expenditure commitments in the near future).
So if we factor in the 3 billion euros “lost” by the Portuguese government in 2011 and look at the fact that it has an even more difficult fiscal target this year then we are back to that famous phrase “Houston we have a problem!” It will be tightening fiscal policy on the back an economy slowing fast and accordingly is likely to end up like a dog chasing its tail. the worst part of this is having done this to Greece the Euro zone has apparently learnt precisely nothing!
Indeed this reminds me so much of back in 2010 when I was writing that the Greek experience was likely to be much worse than projected. Unless something unexpected happens for the better I expect 2012 and probably 2013 to be dreadful years for Portugal and her economy. I wish that their previous finance minster had taken some note of the alternative strategy that I sent him.
Some good news
As a minor antidote to the news above UK inflation as measured by the Consumer Price Index has fallen today to 4.2% from the previous 4.8%. I expect the media to be full of article declaring the equivalent of the end of inflation. As you read them please recall that it is still twice its target in an economic slowdown and that prices rose last month as the CPI index rose from 121.2 to 121.7 (2005=100).
