FRANKFURT (MarketWatch) — First there was debt contagion. Now, Portugal is demonstrating the perils of “restructuring contagion,” as government bond yields soar to euro-era records on fears Lisbon will be forced to follow Greece in seeking to write down the value of its debts.
The trend began earlier this month after Standard & Poor’s Ratings Services downgraded Portugal to junk status, which made the country’s bonds ineligible to be held by some investors. The yield on 10-year bonds jumped more than 1.5 percentage points to a euro-era record of around 15.2% Monday, according to electronic trading platform Tradeweb.
Bond yields rise as prices fall. The short end of the yield curve has also been hit hard over recent days, with the two-year yield seen at 19.2% and the five-year yield at more than 22%.
“At this rate, Portugal is going to move from the back to front burner in very, very short order,” said Dan Greenhaus, chief global strategist at BTIG in New York.
With growth across the euro-zone periphery likely to continue to suffer until a solution to the debt crisis is found, “Portugal’s economic outlook looks unlikely to improve any time soon, leaving it vulnerable to ‘restructuring contagion,’ which we expect will continue, if not intensify, in the wake of Greece’s first restructuring,” wrote Richard McGuire and Lyn Graham-Taylor, fixed income strategists at Rabobank International.
Portugal’s woes have accelerated as Greece and private-sector bondholders work toward a final agreement on a voluntary write down that aims to cut Greece’s total debt load by around 100 billion euros ($131 billion). Read more on talks between Greece, EU leaders.
The European Central Bank had fiercely opposed calls last year by Germany and other European governments to require private bondholders to share the burden of a second bailout by accepting write-downs. ECB officials feared such a move would trigger further contagion across the euro zone.
European officials, including German Chancellor Angela Merkel, have subsequently insisted that private-sector involvement, or PSI, in Greece is a one-time event.
As the debt crisis worsened last year, the consensus forecast for Portuguese economic growth in 2012 fell from 0.8% to negative 3.5%, they noted.
That leaves Portugal potentially in the grip of the vicious circle that has seen efforts at ever more aggressive belt tightening worsen the debt and deficit picture as austerity further sinks growth, the strategists warned.
Portugal, which has suffered from chronic low growth and weak productivity, was forced to seek a bailout from the European Union and International Monetary Fund last year, joining Greece and Ireland.
The country is scheduled to return to the credit markets in 2013.
For that to happen, bond yields would need to fall sharply, which means the Portuguese government will likely attempt to deliver deep structural reforms and austerity this year, said Michala Marcussen, global head of economics at Societe Generale.
If that fails, the only options would be a second bailout package or a Portuguese writedown, she said.
Portugal has failed to benefit from a rush into the short end of peripheral euro-zone bond markets in the wake of last month’s unprecedented injection of long-term liquidity into the euro zone financial system. The ECB provided nearly half a trillion euros of fixed-rate, three-year loans to banks — a move widely credited with helping to pull down yields and support demand for government bonds in Spain and Italy.
The cost of insuring Portuguese debt against default via instruments known as credit default swaps also jumped. Like Greece, CDS spreads for Portugal are now quoted “upfront,” according to data provider Markit, meaning those seeking protection against default must pay in one go rather than spreading payments.
It now costs $3.95 million up front to insure $10 million of Portuguese debt against default for five years.
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