LONDON The European Central Bank's immunity from losses on its Greek bond holdings risks undermining the effectiveness of its secondary market debt purchases in shoring up other weak euro zone issuers such as Portugal.
Funds resentful of the ECB's preferred creditor status in the Greek debt swap, are staying on the sidelines, leaving the central bank the only significant buyer of bonds issued by Portugal - seen as the euro zone state most likely to follow Greece into restructuring.
The problem for the ECB is the more Portuguese debt it buys, the more spooked investors are that the Greek precedent for private bondholders to have to take more of a loss than if the ECB shared the burden could be repeated.
"The ECB's position as assumed preferred creditor...makes its bond-buying program less effective at holding yields down, because the more the ECB's holdings increase, the greater the risk that the remaining private sector holders are pummeled in any eventual restructuring," FxPro chief economist Simon Smith said.
Portuguese bond prices sank last week even after the ECB's latest flood of cheap three-year money, highlighting market skepticism over policymakers' assurances that Portugal will be able to avoid Greece's fate.
Portugal has not benefited from the ECB cash in the same way as Italy and Spain, whose banks used the money to buy sovereign bonds, driving yields lower. This reflects investor anxiety over the state of the Portuguese economy and the terms of the country's 2011 bailout which required banks to raise capital in case loans went sour.
Portuguese 10-year yields have jumped some 80 basis points to just above 14 percent since Wednesday's ECB injection of funds and despite anecdotal evidence from traders that the ECB was buying the debt.
Some strategists see the yield pushing towards the 17.4 percent peak reached at the end of January after the country's credit rating was downgraded to junk.
"It (subordination of private creditors) is very damaging, if you're a Portuguese bondholder now you know that you're going to take on a bigger haircut because of the ECB," said Gabriel Sterne, an economist at Exotix, a frontier market investment banking boutique specialized in illiquid and distressed assets.
"You don't know how much though, because the data (on the ECB's Portuguese bondholdings) are not public. With Greece, it's pretty well factored in already," he said.
Exotix has been active in the Greek debt markets recently and Sterne said they were not yet looking deeply into Portugal, but the country was "high on the to-do list."
The pressure is unlikely to ease on Portugal, given the slew of downbeat economic data this week which stoked fears the euro zone could slide into recession. Without a return to growth, the bloc's weaker debtors risk going into the same downward spiral of economic contraction and higher borrowing costs as Greece.
The benchmark Portuguese 10-year bond is trading at half its face value, signaling investor conviction private bondholders will eventually have to take losses in a Greece-style PSI (public sector involvement) deal.
Another red flag for investors has been the persistent yawning gap between the prices that banks quote to buy Portuguese bonds and those they quote to sell them. The wider this gap, known as the bid/offer spread, the harder it is to make money by buying and selling a financial asset.
Portugal 10 year government bond bid offer spread
"This issue of subordination ...opens another Pandora's box," said Nikolaos Panigirtzoglou, a strategist in JPMorgan's global asset allocation team. "There's a very high chance that Portugal will be subjected to PSI some time in the future, maybe not this year but it could happen next year if it contracts 4-5 percent this year and they miss deficit targets."
"The message from Greece is once you do a lot of austerity measures it's very hard to avoid the pressure and serious contraction."
(Graphics by Scott Barber, additional reporting by Marius Zaharia, editing by Nigel Stephenson)