Portugal Probably Headed for Bailout

Reuters has reported that the parliament in Portugal will likely reject the socialist government’s austerity budget, a move which will precipitate the collapse of that government, new elections and a likely bailout by the European Union. The Portuguese Prime Minister has indicated that he will resign if his budget is rejected as it will force Portugal to follow Greece and Ireland into bailout land.

Andy Lees noted in his morning note in response to the crisis:

What I find fascinating is the way the financial markets temporarily, and necessarily remove political and democratic powers so that reforms can be imposed; i.e. either the parliament supports the reforms or the likelihood is that the government has to go cap-in hand to the IMF and Europe for funds which will come but under more stringent reforms. This highlights that democratic governments really only have the power to take the easy decisions and therefore highlights the asymmetric risks and flaws in the system.

As Marc Chandler wrote yesterday, Portugal’s government is under pressure. The pressure comes in the form of high interest rates on Portuguese debt. Yesterday saw a marked uptick in yields. Foreign buyers have shunned the bonds and domestic institutions and the ECB are the main purchasers at this juncture. Ten-Year yields on Portuguese bonds rose well above 7% to 7.69% yesterday. They have been above 7% for at least 30 days straight now. However, more dramatically, the yield curve is now inverted with five-year Portuguese bonds now yielding over 8% and Portugal fifth on the list of sovereign default probabilities, behind Greece, Venezuela, Pakistan, and Ireland. This suggests markets are gearing not just for a bailout but a deep recession and potentially a default.

Default Probabilities 2011 03 23 thumb

Yesterday’s action in Europe was marred by rumours of a missed interest payment by the beleaguered bailout institution, Allied Irish Bank, causing Ireland’s borrowing costs to also rise. But on the sovereign front, most of the focus was on Spain because of the upcoming EU Summit on Thursday and Friday. If the Portuguese government does indeed collapse on the eve of this summit, it would seem an opportune time to do the bailout.  I believe that is what much of the speculation in Portuguese bonds may be about.

Default Probabilities 2011 03 23 thumb
Default Probabilities 2011 03 23 thumb

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