Markets bet on more aid for Portugal without private sector losses

Wed Sep 18, 2013 11:14am EDT

Related Topics

* Portuguese CDS not far from levels seen in April 2011

* Shape of Portuguese yield curve indicates no panic

* Portugal's default risk 15 pct over next two years-Markit

By Ana Nicolaci da Costa

LONDON, Sept 18 (Reuters) - Debt market prices suggest investors expect Portugal will need another international bailout but that it should avoid a near-term restructuring of its debts that would impose losses on private investors.

Portuguese bonds have been under pressure since May, when the U.S. Federal Reserve flagged its intention to curb bond-buying. Domestic political troubles also took a toll.

The rise in borrowing costs has raised alarm bells, making it increasingly unlikely that Portugal will manage to return to the debt market as planned in the middle of next year.

The cost of insuring Portuguese bonds against default and the premium they offer over German debt last week hit levels seen in April 2011, when Portugal was forced to seek a bailout of 78 billion euros (then $116 billion).

But while some credit default swaps (CDS) price in the possibility of debt restructuring in the future, analysts say bond prices suggest it is not seen as a near-term risk.

Indeed, long-dated Portuguese bonds still offer a yield premium over two-year counterparts. Around the time Portugal secured a bailout in 2011, the yield curve was inverted as investors priced in the risk of imminent default.

"They expect Portugal will get another bailout but they see a low probability that they will go into default or have to undergo a debt restructuring," Alessandro Giansanti, senior rates strategist at ING, said. "That's why you don't see the curve becoming so flat or inverted like it was in 2011."

Greece secured a second bailout in February 2012 and the terms of the deal imposed losses on private bondholders, triggering payments of debt insurance contracts.

The cost of insuring five-year Portuguese bonds against default hit 550 basis points on Friday and the 10-year yield premium over Germany 551 bps after euro zone finance ministers rejected Lisbon's proposal for softer fiscal targets and postponed further debate until November.

On April 7, 2011, the day Portugal requested aid, they stood at 548 bps and 547 bps respectively. Both have eased slightly since Friday's highs.

However, the spread between 10- and 2-year Portuguese yields stood at 148 bps, higher than the lows hit in July when the government was close to collapse and far off levels reached around the time of the May 2011 bailout.

In April and May of that year, the Portuguese yield curve was inverted, with two-year bonds at one point yielding more than 200 bps more than their 10-year counterparts.

Longer-dated bonds usually yield more than short-dated ones to compensate investors for the risk of holding an asset for longer. When short-dated yields overtake long-dated ones, investors see an increased risk the sovereign will not pay them back in the near term.

"The curve is more of a normal shape now than it was back in 2011," Gavan Nolan, an analyst at Markit, said. "What the market is pricing in is (that) there is less of a near-term risk of the CDS being triggered in the next couple of years or so. I think the risks will be further down the line."


Sovereign CDS prices suggest only a 15 percent chance Portugal will default over the next two years, compared with 14 percent at the end of June and this time last year, according to Markit.

Over the next five years, that risk increases to 37 percent, up from 30 percent in late June and 32 percent a year ago.

Some analysts say the latest leg-up in Portuguese yields has been primarily driven by concerns over U.S. stimulus, with ten-year yields up nearly 200 basis points since the Fed in May flagged it could curb bond-buying later this year.

"This is not a typical pricing of a default worry, it is more in line with what is happening globally where the rates environment has changed," said Salman Ahmed, global fixed income strategist at Lombard Odier.

"This is not a liquidity crunch situation like it was in 2011. If the market was afraid that Portugal would run out of money, you would have the curve shaped like in 2011 rather than like it is right now. It's a clear-cut dislike of the long-term credit compared to its peers, rather than anything to do with the fact that there is imminent default coming."

Based on the International Swaps and Derivatives Associations' fair value model, he said CDS spreads are showing a yearly default probability of around 7.5 per year.

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