Portugal & Ireland Remain in Focus

In spite of an all-around outbreak of catastrophe-fatigue and dip buying (what's the worst that can happen, after all? Hasn't it already happened?),  bad news have predictably continued to percolate in Portugal. The latest twist is that prime minister Socrates, who heads a minority government, was unable to pass his austerity budget and thereupon decided  to step down.


Following this exit, it is speculated that new elections will have to be held, but apparently that is not yet certain, as Portugal's president will first ask the political parties whether a different coalition can be formed. In the meantime, Socrates stays on as the 'caretaker' and as such represents Portugal at the EU summit.

The most important fact here is of course that the austerity budget couldn't be passed. Although all relevant political parties in Portugal are in principle pro-austerity (they have little choice in the matter at this point), the PSD (social democratic party) disagreed with the details of Socrates' budget – it didn't want to cut socialist programs quite so much. As the FT reported on that point:

The PSD has committed itself to the same fiscal targets as the Socialist government, which aims to cut the budget deficit to 4.6 per cent of gross domestic product this year and 3 per cent in 2012, down from 7 per cent last year.

But the party, which enjoys a lead in the opinion polls, said it could not support the government’s latest austerity measures because they were likely to prove “limited and ineffectual” and demanded unjust sacrifices from “the most vulnerable members of society."


It appears from this that it shouldn't be relevant which government there is in charge in Portugal. Nonetheless, the markets are aware that an over € 4 billion debt rollover is awaiting Portugal in April, and the buyers' strike in Portuguese debt intensified immediately.



Portugal's 5 year yield hits a new euro era record high at  8.21%



The problem remains that the higher these yields go, the less likely it becomes that Portugal will be able to continue servicing its debt.

In the meantime, ECB chief Jean-Claude Trichet and European Commission president Manuel Barroso both chimed in, urging Portugal to 'stick to its austerity plans', which Socrates promptly promised would happen regardless of who's in charge in Lisbon.

The market's judgment so far is nonetheless that Portugal won't make it. In the meantime, Harvinder Sian at RBS has provided an initial estimate of the size of the bailout that will be required for Portugal. His judgment: € 80 billion.

That's a tidy sum, but manageable for the EFSF. It also means everybody should hope that the market's recently more benign assessment of Spain's creditworthiness proves correct.

The basic problem of course remains unresolved. While the lower interest rate offered by the EFSF means some the burden on Portugal's government finances would lessen, the experience with bailed out peripherals thus far is that their existing bonds simply continue to sell off. – in spite of repeated interventions on the part of the ECB in their bond markets.

A case in point is Ireland – just as it became clear that Socrates would fall, a rumor made the rounds that both Allied Irish Bank and the Republic of Ireland would miss a coupon payment. This was swiftly denied by the relevant functionaries and indeed seems highly unlikely at the moment.

Nonetheless, Irish bond yields found themselves at a new high as well and significantly, remained there even after the denial was broadcast.



Ireland's 5 year yield hits a new high of 10.55%.



Taoiseach (prime minister) Enda  Kenny did not press for a new deal regarding the interest rate Ireland pays to the EFSF at the EU summit, preferring to await the ongoing bank 'stress test' that will supposedly determine just how bottomless the Irish banking well really is. As reported at RTE:

“He [Kenny, ed.] rejected what he called 'extreme figures' being 'bandied about' regarding the scale of the recapitalisation needs in the sector, without specifying what they were.

Earlier, Mr Kenny said he preferred to wait for the banking stress test results before looking for changes to the EU/IMF rescue deal. He said he was more interested in substance rather than theory.

However, speaking in the Dáil today, Sinn Féin said the Government 'completely changed' its negotiation stance in advance of today's EU summit.

Mary Lou McDonald said the Coalition has now said the reduction in the interest rate for the EU/IMF deal is off the table, and that the notion of burden-sharing is 'being kicked down the road'.

She said the Government must explain why it has changed its strategy.”


She has a point. Kenny sounded a lot more combative about one week ago, promising that bank bondholders wouldn't be spared. Presumably his phone call with Hermann Rompuy wasn't the only one he's had since then. It is well-known that the ECB is strenuously seeking to avert haircuts for bank bondholders, no matter how utterly bankrupt the Irish banks evidently are (if it were possible, one could call them 'bankrupt several times over', i.e. creditors would likely recover absolutely nothing). The reason is obvious: firstly, the ECB would then have to come to the aid of the wounded bondholders, which in turn are mostly other banks in the euro area. Secondly, it may well be that in terms of its 'unlimited liquidity provisions' to the euro area banking system, it has ended up accepting some toxic stuff of Irish provenance as collateral itself (we have no proof for this, but it does seem possible).

Since the Irish central bank is essentially printing money by the truckload to funnel unsecured loans to the stricken Irish banks while their deposit base melts away, the goodwill of the ECB seems rather important – at least as long as Ireland remains in the currency union.

In the meantime, Ireland's bonds now require even higher margin, which Clearnet has pushed from 30% to 35%. This should continue to put pressure on the market.

We would once again note to the euro area's bailout fund that it is essentially structured like a CDO. Whether or not anyone wants a 'transfer union', should the 'sub-prime borrowers' financed by the EFSF default after all, then the lenders holding the 'senior tranches', i.e. the bonds the EFSF itself issues, will have to be satisfied via the EU's guarantees. Presto, then it is a 'transfer union', like it or not.

Among those who definitely don't relish this prospect we find Finland (one of the few countries in the euro area with an unblemished score of keeping its deficit below the original Maastricht ceiling of 3% of GDP) and of course Germany. Germany's parliament last week passed a motion directing the government not to agree to the EFSF 'buying bonds of troubled member nations'.

As the WSJ reported:

“Germany's parliament on Thursday approved a motion that explicitly asks the government to bar the euro zone's rescue fund from buying government bonds from troubled member countries.

The vote shows that Angela Merkel's government isn't in line with its own coalition lawmakers. Merkel at a euro-zone meeting last weekend agreed to a purchase of government bonds by the current euro-zone rescue fund, the European Financial Stability Facility, or EFSF.

"I am against the purchase of government bonds as that means that (the fund) is taking over new debt" from those countries, Thomas Silberhorn from the Christian Social Union, or CSU, said in a debate before the vote. "We support the negotiating line of the government, but at the same time put limits to it," he said. The CSU is the Bavarian sister party of Chancellor Angela Merkel's Christian Democratic Union, or CDU.

While the motion isn't binding for the government, parliament is needed to approve any increase in guarantees given by Germany for the EFSF.”


As confusing as this seems to be – it's not binding, which means they now seem to be both for and against it  – it shows the political mood among the putative paymasters. The ECB was extremely eager to get out of the bond buying business, but only partially succeeded in that endeavor (it will be stuck with buying the riskiest stuff in the secondary market, which it has so far done to zero avail).

In that sense, the project 'rescue of the euro at all costs' combined with the 'no bank bondholder to be left behind' program remains a politically fragile one from all sides. Voters are neither eager to be on the receiving end of austerity measures, nor do they want to pay for bailouts. We are likely just one global economic downturn away from the whole enterprise going up in smoke and acrimony.  It may well all hinge on how quickly China's boom goes bust or how long it takes for the markets to realize that money printing can not bring forth a sustainable economic recovery in the US (where e.g. the recently released CFNAI continues to contract – which it has done in 5 of the past 6 months – while new home sales just fell from yet another cliff).



US new home sales – another record low in this series



Below are our usual charts. As can be seen, CDS markets continue to differentiate between various members of the PIIGS club and the ancillary suspects. Correlations have not yet resumed. We strongly suspect that this happy state of affairs won't last, but it has certainly helped to 'buy time'.

As an aside, there are also some questions regarding what actually constitutes a 'credit event'. The ISDA has taken note of the fact that e.g. Ireland's IMF loan enjoys seniority over Ireland's existing government debt. This means effectively that Ireland's previously issued sovereign debt is now subordinated to the IMF's loans. While no-one can say yet how the ISDA will rule on this, it opens the possibility that accepting a bailout from the EU/IMF tag team will be deemed akin to triggering a credit event. 


1.    CDS (in basis points, color-coded)


5 year CDS spreads on Portugal, Italy, Greece and Spain. As can be seen, Portugal and Greece continue their decoupling from Italy and Spain.



5 year CDS spreads on Ireland, Bank of Ireland, France and Japan. Japan's CDS spreads are pulling back the more power lines get connected to the Fukushima Daiichi plant. It is still glowing with varying intensity and  Japan's government had to vastly increase the amount of radiation considered legally harmless, but the worst fears have luckily not been realized and that is what counts.

CDS on Bank of Ireland continue to be well supported in view of pm Kenny's recent tough talk and the upcoming 'stress test'.



5 yr. CDS spreads on Austria, Hungary, Belgium and Romania – evidently the market is no longer all that concerned about these – for now, anyway.


The Markit SovX Index of CDS on 19 Western European sovereigns. Still hovering above lateral support.



2.    Other Charts (note, euro basis swaps are still steady, so not really worth showing at present)


5 yr. CDS on our Middle Eastern Quartet, Saudi Arabia, Qatar, Bahrain and Morocco – consolidating, but somehow still bullish looking actually.



The SPX, T.R.'s proprietary VIX based volatility indicator and the gold-silver and gold-commodities ratios. Amazingly, gold-silver continues its trek lower with some verve. This was 'extremely stretched' a while ago already, but as the next chart shows, could become even more so.


Gold-Silver ratio, the long term view. As long as it keeps moving lower, both metals should be able to continue their rallies. Silver is of course very stretched, as the ratio implies. It is impossible to second-guess where the top in such a strong move may be eventually found, but caution seems advisable (that said, we have seen a good case being made for a technical target of $43 for silver in this move; it's not even very difficult to believe that the old all time high will act like a magnet medium to longer term).


Charts by: Bloomberg


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