17th January 2012
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.
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
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